Follow Six Rules to Avoid Converting Common Areas into Commercial Space
Commercial space isn’t LIHTC basis eligible, but the IRS Code does allow for commercial use at a tax credit site. That commercial space may even be located in the same building where your low-income households live. For example, suppose a 50-unit tax credit building proposes that the entire first floor, except for the lobby to the residential elevators, be set aside for office space, retail shops, and a drug store. This would be acceptable. But the commercial space wouldn’t be included in the basis that’s tied to the credits that can be claimed.
However, if you convert any of your common areas into commercial space after claiming credits, you will cost the owner some of its tax credits. This will result in a recapture. Why? State housing agencies determine how many credits to allocate for a building based on the building’s eligible basis. If you take a common area that’s part of your building’s eligible basis and start using it commercially, that common area is no longer part of the eligible basis. When a building’s eligible basis goes down, the credits the owner can claim go down with it.
Here are six rules you can follow to make sure that you don’t inadvertently convert your site’s common areas into commercial space without the owner’s permission.
Rule #1: Ask Owner What’s Included in Eligible Basis
Find out which facilities in your building are included in the eligible basis. If the owner included a facility, you must keep the facility available to residents and not rent it to the public for commercial use.
For instance, if your building’s community room is often empty in the evenings, you may want to rent the community room for private parties to generate extra revenue. Before you do this, check whether the owner included the community room in your building’s eligible basis. If the owner did include the room, renting it for parties will convert a common area into commercial space. And the owner won’t be entitled to claim any credits for the community room.
Rule #2: Use Market-Rate Building for Commercial Activities
Often a single tax credit allocation will be awarded to a site that consists of more than one physical building. Each building will receive its own IRS Form 8609. Unless otherwise elected by the owner, each building at the site will be treated separately. If you manage a site that includes a market-rate building—a building in which you don’t have any units you must rent to qualified low-income households—you should run your commercial activities from that building.
Owners don’t claim credits for market-rate buildings. Therefore, you don’t have to worry if you convert any part of these buildings into commercial space. And because eligible basis is calculated separately for each building at a tax credit site, running commercial activities from a market-rate building won’t affect the eligible basis of any low-income building at the site. But be sure to double-check that the facility from which you run commercial activities is included only in your market-rate building’s eligible basis—and not in the eligible basis for your mixed-income or low-income buildings.
It’s important to note that although running commercial activities at market-rate buildings won’t affect the owner’s tax credits, you must still get all necessary licenses and approvals from your city or state. If you’re not sure which licenses or approvals you need, have your attorney check your state and local laws. For instance, you may need approval from your local zoning board before offering meals to residents. Also, make sure that your liability insurance adequately covers the activities you run.
Rule #3: Don’t Charge People or Companies to Use Common Areas
The eligible basis along with the qualified basis of the site includes all tax credit units as well as common areas. Don’t charge anyone for the use of common areas that are included in your building’s eligible basis. If a common area is in the basis, fees may not be charged even to market-rate residents. In other words, if parking, pools, tennis courts, and other types of common areas are included in the eligible basis, no separate fees can be charged.
You can let people—or even companies—use the space for free, however. And you can let businesses that use the space charge your residents a fee for their services—as long as you don’t collect any percentage of those payments.
For instance, you can’t rent space in your community room to a hair salon. But you can let a hairdresser use your community room free of charge. Residents may pay the hairdresser directly for this service. But you mustn’t accept any part of those payments.
Rule #4: Don’t Let Anyone Use Common Area to Offer Services to the Public
If you let people or companies use your site’s common areas to provide services free of charge, make sure they don’t offer any services to the general public. For instance, if you let a hairdresser use your community room, tell the hairdresser that he may provide services only to your residents—not to members of the general public.
Rule #5: Consider Ramifications If Renting Rooftop Space
Telecommunications companies often approach managers about renting rooftop space to install antennas to transmit signals for cell phones. By entering these deals, tax credit owners can make thousands of dollars in extra revenue. But because such deals require owners to use their roofs for commercial purposes, it can also cost owners some of their tax credits.
If you manage a multi-building site that includes a market-rate building, you can rent space on the roof of that building without putting the owner’s credits at risk. But if you don’t have a market-rate building at your site, the problem with renting space on the roof of a low-income building is that the roof is part of the building’s eligible basis. Renting to telecommunications companies will convert your roof into commercial space, which will lower your building’s eligible basis, costing the owner some tax credits.
Despite the potential for tax credit loss, some owners may make deals with telecommunications companies because the profits they make from the rent payments justify the loss. If you and the owner choose to rent rooftop space on a low-income building, you should tell the owner not to claim credits for the entire roof. Be sure that the owner speaks with a tax credit consultant or attorney to find out how a potential deal that you’re considering will affect its credits.
Rule #6: Don’t Offer ‘Continual or Frequent’ Medical or Nursing Services
The IRS won’t consider your tax credit building residential if you provide “continual or frequent” medical or nursing services to your residents. The IRS has stated that a tax credit site must be residential in nature, and many questions have arisen about services and medical use at a tax credit site.
According to the IRS, “The furnishing to tenants of services other than housing (whether or not the services are significant) does not prevent the units occupied by tenants from qualifying as residential rental property eligible for credit under Section 42(g) [26 CFR §1.42-11(a)].” This provision allows for supportive services such as meals, transportation, and housekeeping without your building losing its status. Offering these services shouldn’t jeopardize the owner’s tax credits. But it’s a good idea to check with your attorney or tax credit consultant before offering any new service to your residents.
However, the IRS draws the line between supportive services and medical use. In the General Explanation of the Tax Reform Act of 1986, it states that “…no hospital, nursing home, sanitarium, life care facility, retirement home providing significant services other than housing…may be a qualified low income project.” But remember than you cannot prevent a resident from privately hiring for services including medical. This would be a violation of fair housing laws.