How to Comply with Minimum Set-Aside Requirements
For a building or site to qualify for the tax credit program, an owner must rent at least a certain percentage of the units to qualified low-income households. These households can earn no more than a specified amount of income. This requirement is called the “minimum set-aside,” and every tax credit site must meet and maintain this requirement throughout the 15-year compliance period to continue earning tax credits. In fact, 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, warns tax credit consultant A.J. Johnson.
Before you begin leasing units at a tax credit site, you must know exactly what decisions the owner has made about the minimum set-aside. If you don't know, you might lease too many units to unqualified households. Most likely, this will be a problem you won't be able to fix even if you discover it before the set-aside deadline, warns compliance expert Ruth Theobald Probst. This is because you'll have to wait until your unqualified households' leases expire before you can re-rent those units. If you don't meet the set-aside on time, the owner won't be able claim tax credits for the entire building.
With so much at stake, it's essential that you get all the key information about your set-aside—such as how many low-income units must be rented, what makes a household qualified, and how much time there is to comply—from the owner before you begin to lease your units. This way, you'll avoid renting the wrong units to market-rate households or to households that you mistakenly believe are qualified low-income households because you've used the wrong set-aside test.
To help you make sure you get this information, you can use our Model Form: Gather Information Needed to Meet Minimum Set-Aside Requirement. By speaking with the owner and filling out the form before lease-up, you'll know exactly how to ensure that your building or site meets the minimum set-aside and that the owner can continue to claim its tax credits.
Minimum Set-Aside Basics
All tax credit site owners must formally notify the IRS of their minimum set-aside election for their building or site when they file IRS Form 8609. The minimum set-aside is expressed as two numbers, separated by a hyphen. For example, the numbers may be 20-50 or 40-60. The first number indicates the percentage of units at your site that you must rent to qualified low-income households. The second number refers to the highest income these households can earn to be qualified, expressed as a percentage of area median gross income (AMGI). For example, if your set-aside is 40-60, then you must rent at least 40 percent of your units to households earning no more than 60 percent of AMGI.
Per-site or per-building basis. Whether or not you can total all the units across different buildings for purposes of meeting the minimum set-aside depends on the owner. For a multi-building site, the owner may elect to meet its minimum set-aside based on the entire site, counting all the units in all the buildings together, or by meeting the minimum set-aside for each building individually.
To figure out whether the owner elected to meet its minimum set-aside based on the entire site, look at line 8b on IRS Form 8609, Low-Income Housing Credit Allocation and Certification. This line asks: “Are you treating this building as part of a multiple building project for purposes of section 42?” If the owner checked yes, then you may aggregate all units from all buildings to satisfy the minimum set-aside for the project.
For example, suppose you manage five 20-unit buildings (#1 to #5) on a site. The owner told you the minimum set-aside for the project is 40-60, meaning 40 units of the 100-unit site (40% x 100) must be occupied by qualified low-income households having below 60 percent of the area median gross income. If you choose, you may satisfy the minimum set-aside by, for example, renting 20 units in building #1 and 20 units in building #2 to qualified low-income households. In that case, you may lease all units in the other three buildings to market-rate households.
According to the instructions to Form 8609, two or more qualified low-income buildings may be included in a multiple building project only if they:
Are located on the same tract of land, unless all of the dwelling units in all of the buildings being aggregated in the multiple-building project are low-income units [Section 42(g)(7)];
Are owned by the same person for federal tax purposes;
Are financed under a common plan of financing; and
Have similarly constructed housing units.
A qualified low-income building includes residential rental property that is an apartment building, a single-family dwelling, a townhouse, a row house, a duplex, or a condominium.
Determining deadline for meeting set-aside. You should ask the owner when it plans to begin claiming tax credits. 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. Your deadline for meeting the minimum set-aside is the last day of the first taxable year the owner claims credits, Probst explains. This year is either the placed-in-service year or the following year.
An owner doesn't commit to a deadline until it files its Form 8609, writing its choice on line 10a of the form. But the owner should let you know its plans before lease-up so you will know how much time you have to meet the set-aside, notes Probst. Also, 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.
Determining how many low-income units to rent. The minimum set-aside is always calculated as a percentage of units. It's never based on a percentage of square feet of the property. You should ask the owner which test you'll be using to meet the minimum set-aside. The choices are 20-50, 40-60, or for sites in New York City only, 25-60. The owner must elect a set-aside test on line 10c on IRS Form 8609. But the owner should let you know which test to use before lease-up so that you can meet the set-aside on time. Once you know the percentages, you can calculate the number of units that you must rent to qualified low-income households.
Most owners will want to set aside extra units to rent to low-income households above the required number of units determined by the minimum set-aside. One reason is to meet the owner's target for its first-year fraction. In most cases, the applicable fraction represents the maximum number of units for which the owner can claim tax credits or the percentage of units in the building covered by the credit allocation. Generally, the owner's goal is to maximize the number of units for which it can earn a credit. In other words, if you meet the set-aside but miss the owner's target, the owner may not be able to claim tax credits for some of your units, Probst cautions.
Another reason for setting aside extra designated low-income units is to give yourself some leeway. While you may lose rental income by charging restricted rent to those units, it will be much easier to maintain the minimum set-aside. Remember, if you don't maintain the minimum set-aside during any year of the compliance period, the IRS may recapture all the tax credits the owner claimed for the building or site.
Deep rent-skewed. You should ask the owner whether it wants your site to be deep rent-skewed. Deep rent-skewing is an attractive option if you manage a site in a city where market-rate rents are high, says Probst. When renting low-income units at a deep rent-skewed site, an owner must meet even tougher income restrictions than the minimum set-aside requires. But in return for these tougher restrictions, the owner enjoys certain advantages, such as not having to make market-rate units available if a low-income household goes over-income.
If your site is deep rent-skewed, you'll need to meet the 15-40 deep rent-skewed set-aside in addition to the minimum set-aside, says Probst. This means that you must rent 15 percent of all your low-income units including any elected extra units to households earning no more than 40 percent of AMGI.
The owner's deadline for deciding whether to make its site deep rent-skewed is the day it fills out line 10d and files Form 8609 with the IRS. But you'll need to know the owner's wishes before lease-up so you can meet the deep rent-skewed set-aside on time.
A.J. Johnson: President, A.J. Johnson Consulting Service, Inc., 3521 Frances Berkeley, Williamsburg, VA 23188; www.ajjcs.net.
Ruth Theobald Probst, CPM, HCCP, SHCM: President, TheoPRO Compliance & Consulting, Inc., 21150 W. Capitol Dr., Ste. 3, Pewaukee, WI 53072; www.theopro.com.
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