How to Avoid Six Common Minimum Set-Aside Requirement Mistakes

Meeting your site’s minimum set-aside is the most important goal you have as a tax credit manager. If you meet the set-aside, the owner of your site will be entitled to claim its tax credits. If you don’t meet the set-aside, your site won’t qualify for the tax credit program, which means the owner won’t be able to claim any of the credits it was allocated.

To make sure this doesn’t happen to you, we’ll tell you about six common mistakes managers make in complying with the minimum set-aside requirement. And we’ll tell you how you can avoid making these mistakes at the tax credit sites you manage.

Mistake #1: Meeting Minimum Set-Aside Too Late

Too often, tax credit managers aren’t mindful of the deadline for meeting the minimum set-aside at their building or site. If you meet the set-aside after the deadline, all your efforts at finding qualified low-income households will be in vain. Being even one day late can lead to tax credit trouble.

How to avoid. When you begin managing a tax credit site, note the deadline for meeting the site’s minimum set-aside. And keep in mind that if the owner elected to meet the set-aside on a per-building basis, you may have different deadlines for your buildings.

If you’re not sure when the deadline is, look at line 10a on the owner’s IRS Form 8609. This line asks whether the owner “elect[s] to begin credit period the first year after the building is placed in service.” If the owner checked “no,” the deadline for meeting the set-aside is the end of the placed-in-service (PIS) year. But if the owner checked “yes,” the deadline is the end of the taxable year after the PIS year.

Mistake #2: Assuming It’s OK to Meet Minimum Set-Aside for All Buildings Combined

Some managers of multibuilding sites assume that they must meet just one set-aside for all their buildings combined. But often the owner will have agreed to meet a set-aside for each building separately—or even for each of several groups of buildings. If you don’t know what the owner agreed to, chances are that you’ll rent your units to qualified low-income households in such a way that one or more of your buildings won’t qualify for the tax credit program. And you won’t realize your mistake until it’s too late to correct.

For example, suppose you manage a tax credit site with two buildings, 20 units in each. Suppose that your minimum set-aside is 20-50 and the owner agreed to meet the set-aside on a per-building basis. This means that you must rent a minimum of four units (20 percent of 20 units) in each building at your site to qualified low-income households. If you mistakenly assume that you can meet the set-aside on a per-site basis, you’ll assume that you’ll meet it as long as any eight units at your site are low income. So you might rent, for instance, only two units in one building and six units in the other to qualified low-income households. As a result, the building with the two low-income units would fall short of its set-aside, disqualifying it from the tax credit program.

How to avoid. If you’re not sure how to meet the set-aside when you manage a multibuilding site, check with the owner to find out what it elected. Owners must commit to their decision when they file Form 8609-line 8b, which asks whether the owner is “treating this building as part of a multiple building project.” If an owner checks yes for each building, then you must meet one set-aside for all the buildings combined.

Mistake #3: Using Same Household to Qualify Multiple Units

Some managers have tried to use the same household to qualify more than one unit as low income. It’s true that leasing up enough units to meet the set-aside on time can be stressful. But this seemingly time-saving strategy will only lead to noncompliance.

How to avoid. Don’t try to use the same household to qualify more than one unit at your site as low income. If you need to transfer a low-income household shortly after move-in, just follow the unit transfer rule to determine the status of the new and old units. Under that rule, if you move a household to another unit in the same building at your site, the two units swap status.

For example, suppose you lease up Unit 4A, an empty unit at your site, to a qualified low-income household. That unit is now a low-income unit. Suppose that after move-in, a household member breaks her leg and asks you to transfer her household to Unit 1A, an empty unit on the ground floor. If you grant this request, under the unit transfer rule Unit 1A then becomes a low-income unit and Unit 4A becomes an empty unit. You must then find a new qualified low-income household to qualify Unit 4A as low income.

If you move a household to a unit in a different building at your site, the situation is more complicated. The income of the household that’s requesting the transfer should be tested against the current income limits to ensure that the Available Unit Rule is not violated. In other words, you must test the household’s eligibility once more, redoing its initial certification to check if the household qualifies for a low-income unit.

If the household’s income changed or if the minimum set-aside is more restrictive in the other building, the household might not qualify. If the household qualifies and transfers from its old unit to a new building, the new unit becomes low income. As for the status of the old apartment, the IRS and most state housing agencies have generally been unwilling to let the same household qualify two units. So it’s likely that the old unit would be considered empty. If your state housing agency takes this position, you would need to requalify that unit by renting it to a new low-income household.

To help you keep track and certify unit transfers within the same LIHTC project, we’ve provided a Model Form: Document Unit Transfers within the Same Site, which you can use to help maintain compliance with respect to set-aside elections and the Available Unit Rule.

Mistake #4: Using Wrong Definition of Low-Income Household

Most managers know that they must rent a minimum number of units—for example, 20 percent—to qualified low-income households to meet and maintain the minimum set-aside. But some managers get tripped up on how a low-income household is defined. A low-income household isn’t defined the same at each site.

How to avoid. Find out how a low-income household is defined at your building or site. To do this, look at your minimum set-aside test. If you’re not sure what test you must use, refer to line 10c on Form 8609. The test is expressed by two numerals, usually separated by a hyphen. The first numeral says what percentage of units you must rent to low-income households. The second numeral gives you the definition of a low-income household. So if the minimum set-aside for one of your buildings is 40-60, a low-income household is a household that earns no more than 60 percent of area median gross income (AMGI).

Mistake #5: Not Maintaining Minimum Set-Aside After First Year

Some tax credit managers think they can relax after meeting the minimum set-aside in the first year. But complying with the minimum set-aside requirement also means making sure that your building or site maintains its set-aside in each remaining year of the 15-year compliance period. If you rent enough units to qualified low-income households by the end of the first year of the compliance period but fall short of the set-aside in a later year, your building or site will no longer qualify for the tax credit program. And the IRS may recapture the owner’s credits dating back to Year 1.

How to avoid. Don’t forget about the minimum set-aside after you meet it in the first year. To avoid tax credit recapture, make sure you rent enough units to qualified low-income households to maintain your set-aside in each remaining year of the 15-year compliance period.

Mistake #6: Discarding Files that Prove Compliance with Set-Aside Requirement

Tax credit managers sometimes find themselves in the frustrating position of having complied with the minimum set-aside requirement but not being able to prove it to their state housing agency or to the IRS.

How to avoid. Follow the tax credit record-keeping rules. These rules require you to keep documentation showing, among other things, that you certified each household’s income and that you rented enough units each year to qualifying households.

For Years 2 to 15 of the compliance period, you must keep your files for six years after the deadline for the owner to file its tax return for that year. Because meeting your set-aside in the first year is so important, the IRS requires you to keep your first-year files until six years after the deadline for the owner to file its tax return for the 15th year of the compliance period. Since the owner claims its credits over only 10 years, this means that you must hang on to your first-year files for 11 more years after the owner has stopped claiming its credits.