Follow Five Dos & Don'ts to Comply with the Vacant Unit Rule
When a qualified low-income household moves out of a unit at your tax credit site, you might not have another qualified household immediately available to move into the unit. And finding qualified households for your site can be difficult and take time. For these reasons, you may have units that have been vacant for a considerable amount of time. Fortunately, the tax credit law lets owners continue to claim credits for units that become vacant, as long as they comply with the vacant unit rule. This rule allows credits to be claimed if a LIHTC eligible household moves out and with reasonable attempts to rent the unit, it remains vacant. The vacant unit still counts towards the set-aside and qualified basis. As the manager of a tax credit site, you’re responsible for making sure your site complies with this rule. One mistake can lead to a loss of the owner’s tax credits.
We’ll give you a list of five dos and don’ts to help you and your staff avoid making mistakes that can lead to noncompliance.
Vacant Unit Rule Basics
Under Treasury Regulation §1.42-5(c)(1), taxpayers are required to certify to the state agency that allocated the credit at least annually that, for the preceding 12-month period, that the site was operated in compliance with IRC §42 requirements. One of the 12 requirements for annual certification is compliance with the vacant unit rule.
When a qualified low-income household moves out of a unit, the unit is called a “vacant unit.” Although a qualified household is no longer living in the unit, the owner can continue to claim credits for the unit as long as you comply with the vacant unit rule. To comply, you must make reasonable attempts to rent the vacant unit (or other available units of comparable or smaller size) to qualified low-income households, and you must not rent any other units of comparable or smaller size to nonqualified households as long as the unit stays vacant.
The rule affects mainly mixed-income sites, which have both low-income and market-rate units. That’s because, at 100 percent sites, every vacant unit must be rented to a qualified household, anyway. But even at a 100 percent site, you can’t let your vacant units stay vacant. You must make reasonable attempts to rent them to qualified low-income households so that the owner can continue to claim credits.
Comply with the Vacant Unit Rule on a Per-Site Basis
If your site has more than one building, you must tell your staff members to comply with the vacant unit rule on a per-site basis—not a per-building basis. Under Treasury Regulation §1.42-5(c)(1)(ix), if a low-income unit in the project became vacant during the year, reasonable attempts must be made to rent that unit or the next available unit of comparable or smaller size to tenants having a qualifying income before any units in the project were or will be rented to tenants not having a qualifying income.
If your staff members comply on a per-building basis, they’ll probably be making mistakes that can cost the owner its tax credits for the vacant unit. And if the owner needed to count the vacant unit to meet its building’s minimum set-aside, the owner may risk losing all the credits for the building.
For example, ABC Apartments is a two-building tax credit site with 20 units per building. Each building’s minimum set-aside is 40–60, which means that at least eight units in each building must be rented to qualified low-income households. A few years into the compliance period, one of the eight qualified low-income households in Building A moves out.
The manager of ABC Apartments must now make reasonable attempts to rent the vacant unit or the next available unit of comparable or smaller size at the site to a qualified low-income household. Within a week, a unit of comparable size becomes available in Building B. But the manager rents the unit in Building B to a market-rate household because he believes that the vacant unit rule applies on a per-building basis. A month later, a unit of comparable size becomes available in Building A, and the manager rents this unit to a qualified low-income household. Because he rented the next available unit (the unit in Building B) to a market-rate household, the manager didn’t comply with the vacant unit rule. This means that the owner won’t be able to claim credits for the vacant unit in Building A. And since the owner needed to count that unit to meet the building’s minimum set-aside, all its credits for Building A may be recaptured.
Remember that, unlike the vacant unit rule, the next available unit (NAU) rule applies on a per-building basis. So if you have more than one building at your site, make sure your staff understands that it must comply with the vacant unit rule and the NAU rule differently.
Don’t Rent Market-Rate Units to Nonqualified Households During Vacancy
When you have vacant units, don’t rent any market-rate units of comparable or smaller size to nonqualified households until you’ve rented all the vacant units to qualified low-income households.
It’s true that this may cost the owner some rental income because market-rate units may have to stay unoccupied while you and your staff make reasonable attempts to rent vacant units. But the alternative, losing credits for not complying with the rule, is far more costly.
Don’t Rent Vacant Units Before Empty Units
Don’t rent vacant units before you rent units that have never been occupied. Tax credit owners can’t begin claiming credits for a unit until a qualified low-income household occupies it. Before a unit has been occupied, the unit is known as an “empty unit.” Tell your staff members that, when faced with a choice, they should rent empty units before vacant units. If you don’t rent your empty units first, the owner will have to wait longer to start claiming tax credits for the empty units. Besides, moving qualified households into empty units is essential during lease-up because you must make sure your buildings meet their minimum set-aside and the owner’s target for their first-year fraction.
Make Reasonable Attempts to Rent Vacant Units
To comply with the vacant unit rule, you must make “reasonable attempts” to rent vacant units to qualified low-income households. IRS Revenue Ruling 2004-82, Q&A #9, outlines what amounts to reasonable attempts. According to the ruling, the determination is made on a case-by-case basis, considering the facts and circumstances, and may differ from site to site depending on factors such as the size and location of the project, tenant turnover rates, and market conditions. Also, the different advertising methods that are accessible to owners and prospective tenants would affect what’s considered reasonable. Question 9 in the revenue ruling included the following examples:
- Banners and for-rent signs at the entrance to the project;
- Classified advertisements in local newspapers;
- Maintaining a waiting list and contacting prospective low-income tenants; and
- Using a local public housing authority list of Section 8 voucher holders to identify and contact potential tenants.
Overall, keep records of your marketing efforts, including copies of all your advertisements and flyers, so you can show your state housing agency that you made reasonable attempts. And remember that your attempts don’t have to be successful for your agency to consider them reasonable.
Get Advice on Binding Reservation Exception
Ask your attorney about local laws concerning when a contractual arrangement that’s binding on the owner is made with regard to renting apartments. Under tax credit rules, the binding reservation exception says that a unit isn’t available to rent when it’s “subject to binding contractual arrangements under local law.” This means, for instance, that if an applicant gives you a deposit for a unit and, under local law, you’re required to hold the unit for her, the unit isn’t considered available.
The timing of when deposits were made or leases signed for vacant and market-rate apartments may affect compliance with the vacant unit rule. For example, as provided in IRS Revenue Ruling 2004-82, Q&A #10, suppose a building has 10 units of comparable size, consisting of seven low-income units (none was an over-income unit) and three market-rate units. All units in the building were occupied except for one market-rate unit. A low-income unit became vacant on March 15. Between March 15 and March 29, the owner made reasonable attempts to rent this unit to an income-qualified tenant. The vacant low-income unit became subject to a reservation (a contractual arrangement that’s binding on the building owner under local law prior to the date a lease is signed or the unit is occupied) on March 29, under which the owner agreed to rent the unit to A, whose income meets the income qualifications for the site. Thereafter, the owner ceased any efforts to attempt to rent the unit. On April 30, A signed a lease for the unit and occupied the unit on May 1. The vacant market-rate unit was rented to a market-rate tenant on April 15.
Here, the owner did not violate the vacant unit rule. The vacant low-income unit was subject to a reservation that was binding under local law prior to the renting of the vacant market-rate unit, the low-income unit wasn’t available when the market-rate unit was rented. Accordingly, the owner no longer needed to make reasonable efforts to rent the low-income unit.
Be sure to get your attorney’s advice on what’s considered a binding reservation under your local law. For instance, taking a deposit from an applicant may not be a binding reservation in all states.