# Four Common Misconceptions About the Applicable Fraction

The applicable fraction is the percentage of rental units in a building that qualify as low-income units. Specifically, under Internal Revenue Code (IRC) §42(c)(1)(B), the applicable fraction is the smaller of the unit fraction or the floor space fraction. IRC §42(c)(1)(C) defines “unit fraction” as a fraction whose numerator is the number of low-income units in the building, and whose denominator is the number of residential rental units in such building.

The applicable fraction is the percentage of rental units in a building that qualify as low-income units. Specifically, under Internal Revenue Code (IRC) §42(c)(1)(B), the applicable fraction is the smaller of the unit fraction or the floor space fraction. IRC §42(c)(1)(C) defines “unit fraction” as a fraction whose numerator is the number of low-income units in the building, and whose denominator is the number of residential rental units in such building. And IRC §42(c)(1)(D) defines “floor space fraction” as a fraction whose numerator is the total floor space of the low-income units in such building, and whose denominator is the total floor space of the residential rental units. Floor space includes the entire footprint of the unit, including closets within the unit and balconies attached to the unit for the sole use of the tenants occupying the unit.

An owner reports the applicable fraction yearly on Form 8609-A, Annual Statement for Low-Income Housing Credit. This information is important because it determines whether the site’s owner may claim all the tax credits it was allocated. But many tax credit managers have misconceptions about the applicable fraction. If you’re one of those managers, you may be unwittingly putting the owner’s tax credits at risk. Here are four common misconceptions about the applicable fraction requirement that can trip up tax credit managers.

## Misconception #1: You Can Meet Applicable Fraction Requirement Per Site or Per Building

You must always meet the applicable fraction requirement on a per-building basis. So if you manage a multi-building tax credit site, this means you’ll need to meet a separate applicable fraction for each of your buildings.

Some managers get confused because they don’t always have to meet the minimum set-aside on a per-building basis. Their sites’ owners may choose to meet one set-aside for the entire site, for each building separately, or for any combination of buildings. But regardless of how you must meet your site’s set-aside, you must always meet a separate applicable fraction for each building.

## Misconception #2: Applicable Fraction Depends Only on Number of Low-Income Units

The applicable fraction, unlike the minimum set-aside and other low-income occupancy requirements you may have, depends on the number of low-income units and the size of those units. To calculate the applicable fraction for a building, you must take the lesser of the building’s unit fraction (the number of low-income units divided by the building’s total units) and its floor space fraction (the floor space of the low-income units divided by the total floor space of all units).

For example, suppose you manage a single-building tax credit site with eight units, with floor space totaling 8,000 square feet. The owner’s target for the first-year fraction (that is, the applicable fraction in the first year of the compliance period) is 60 percent. This means that you must meet a first-year fraction of at least 60 percent to ensure the owner is entitled to claim all its credits from the start. On the last day of the first year of the site’s compliance period, you have five units (with floor space totaling 4,500 square feet) rented to qualified low-income households.

You calculate the building’s unit fraction as 62.50 percent (five low-income units divided by eight total units). You calculate the building’s floor space fraction as 56.25 percent (4,500 square feet of low-income units divided by 8,000 square feet of all units). The floor space fraction is lower than the building’s unit fraction, so it’s the building’s first-year fraction. At 56.25 percent, it falls short of the owner’s target of 60 percent.

Another example that illustrates this is if 75 of 100 units are rented at year-end: If all the units are the same size, the building’s unit fraction is 75 percent. But if the units are different sizes and the 75 rented units equal 60 percent of the square footage, the applicable fraction is the lesser of the unit fraction or the floor space fraction. In this example, the applicable fraction is 60 percent.

## Misconception #3: You Can Calculate Applicable Fraction Using Monthly Average

During each year of your site’s compliance period, you must calculate the applicable fraction for each building at the site on the last day of that year [IRC §42(c)(1)(A)]. For instance, to properly determine the first-year fraction, you must calculate the applicable fraction on the last day of the first year of the compliance period. It doesn’t matter how many units were occupied before the last day of the year.

For example, suppose you manage a “100 percent” single-building tax credit site, which means you must try to establish and maintain an applicable fraction of 100 percent for the building. In October of the first year of the site’s compliance period, you’ve rented roughly half of your units to qualified low-income households. On Dec. 31, all the units are rented to qualified low-income households. Because a building’s applicable fraction must be determined on the last day of the year, you’ve succeeded in establishing a first-year fraction of 100 percent for your building.

However, don’t confuse the first-year fraction with the prorated fraction. The prorated fraction, which is used only to calculate the amount of credits an owner may claim for the first year, takes into account the percentage of a building’s units rented to low-income households during each month of the first year.

## Misconception #4: Owners Can’t Later Claim More Credits if First-Year Fraction Falls Short of Target

The owner of any tax credit site you manage must choose a target for its buildings’ first-year fraction. If you meet the owner’s target, the owner will be entitled to claim all the credits it was allocated for its buildings. If you fall short of the target when meeting the first-year fraction for a building but increase your applicable fraction in a subsequent year, the owner can then become entitled to claim more credits. In this situation, owners generally may claim these extra credits for the rest of the 15-year compliance period at two-thirds’ value.