Improve Your LIHTC Vocabulary with the IRS Audit Technique Guide
In January 2014, the IRS released a draft version of the Section 42 Audit Technique Guide. The audit technique guide was prepared to assist IRS examiners audit owners of tax credit sites. The audit technique guide consists of 20 chapters, in nine parts, plus 10 appendices that include case law to illustrate examples of litigation concerning tax credit issues such as eligible basis, credit recapture, and nonprofit participation. The guide will be published in its final form later this year.
The audit technique guide can be an informative resource for owners and managers of tax credit sites. Similar to the Guide for Completing Form 8823, it gives owners insight into the IRS’s interpretation of the Section 42 regulations. The guide also provides a glossary. We’ve pulled a sampling of terms from the glossary. You can test your low-income housing tax credit vocabulary against the following list.
Applicable Fraction: The portion of rental units that are qualified low-income units; determined as the smaller of the unit fraction or square footage fraction. IRC §§42(c) & 42(f). See “Unit Fraction” and Floor Space Fraction.”
Available Unit Rule: If the income of an existing tenant rises above a specified amount, the next available comparable unit in the building must be rented to an income-qualified tenant. Otherwise, the “over-income” unit ceases to be a low-income unit. IRC §42(g)(2)(D) and Treas. Reg. §1.42-15.
Binding Commitment: A commitment by a state agency to allocate a specified credit amount beginning in a specified later year. The commitment must be made no later than the close of the calendar year in which the building is placed in service. IRC §42(h)(1)(C).
Carry-Over Allocation: An allocation of credit with respect to a qualified building which is placed in service not later than the close of the second calendar year following the calendar year in which the allocation is made. IRC §42(h)(1)(E) and Treas. Reg. §1.42-6.
Certification, First Year: Taxpayers are required to complete a certification with respect to the first year of the credit period. The certification is made by completing Part II of the Form(s) 8609 executed by the state agency to document the allocation of low-income housing credits. IRC §42(l)(1).
Compliance Period: To qualify for the credit, the taxpayer must provide affordable housing for 15 years, which is known as the compliance period, beginning with the first taxable year of the credit period with respect to the building. IRC §42(i)(1).
Difficult to Develop Area: A subset of “high cost area.” Any area designated by HUD as having high construction, land, and utility costs relative to area median gross income. IRC §42(d)(5)(B)(iii)(I). Also, buildings designated by state agencies can be treated as located in a difficult to develop area as long as the building is not financed with tax-exempt bonds. IRC §42(d)(5)(B)(v).
Eligible Basis: The total costs (adjusted basis) associated with the depreciable residential rental property qualifying for the credit at the end of the first year of the credit period and without regard to any deduction for depreciation. If the building is located in a high cost area, the eligible basis may be increased to as much as 130 percent of the actual costs. IRC §§42(d) and 42(e).
Extended Use Period: The period of time that an extended low-income housing commitment is in effect, beginning on the first day in the compliance period and ending on the later of the date specified by the state agency in the commitment or the date which is 15 years after the close of the compliance period. There are exceptions if the building is acquired by foreclosure (or instrument in lieu of foreclosure) or if no buyer is willing to maintain the low-income status. Both exceptions are subject to certain restrictions. IRC §42(h)(6)(D) and (E).
Final Cost Certification: To ensure that the credit allocated to a project does not exceed the amount necessary to assure its feasibility and long-term viability, the state agency must evaluate the taxpayer’s sources and uses of funds and the total financing planned for the project, the proceeds (capital contributions) expected to be generated by the tax benefits, the percentage of the housing credit dollar amount used for project costs other than the cost of intermediaries, and the reasonableness of the developmental and operational costs of the project. The evaluation is completed when the taxpayer applies for the credit, when the credit is allocated (usually a credit carry forward allocation), and again when the project is placed in service. This last evaluation is commonly referred to as the Final Cost Certification and is based on actual costs incurred through the end of the first year of the credit period. IRC §42(m)(2) and Treas. Reg. §1.42-17(a)(5).
Form 8823, Low-Income Housing Credit Agencies Report of Noncompliance or Building Disposition: Submitted to the IRS by the state agency to report noncompliance with IRC §42 requirements or dispositions of property (or interests therein). Treas. Reg. §1.42-5(e)(3).
High Cost Area: For any new building located in a qualified census tract or difficult to develope area, the eligible basis can be increased by up to 130 percent of the eligible basis otherwise determined. The same holds true for rehabilitation expenses treated as a new building under IRC §42(e). IRC §42(d)(5)(B).
Household, Student: A household composed entirely of full-time students is not considered a qualified low-income household unless the household is “excepted” by satisfying certain conditions. IRC §42(i)(3)(D).
Imputed Income Limit: For purposes of restricting the rents under IRC §42(g)(2), an imputed income limitation is used. It is based on the number of bedrooms in the unit and uses the income limit that would apply if each separate bedroom was occupied by 1.5 individuals. For a unit that does not have a separate bedroom, one person is deemed to occupy the unit. IRC §42(g)(2)(C).
Inspections by State Agency: Tenant records and the project are subject to physical inspection by the state agency. Treas. Reg. §1.42-5(c)(2).
Lease, Nonrenewal: A taxpayer is not obligated to renew a lease or enter into a new lease with an existing low-income tenant, and failure to do so does not, per se, constitute an eviction without good cause. However, the taxpayer must provide timely notice that the lease will not be renewed as required under state law and be prepared to demonstrate, if challenged in state court, that the nonrenewal of a lease is not a “termination of tenancy” for other than good cause under IRC §42.
Market Study: A comprehensive market study of the housing needs of low-income individuals in the area to be served by a proposed IRC §42 project is conducted before the credit allocation. Generally, the developer pays for the study, which is completed by a disinterested party approved by the state agency. IRC §42(m)(1)(A)(iii).
National Pool: A state’s unused housing credit carryover for any calendar year that is assigned to the IRS for reallocation among qualified states for the succeeding year. IRC §42(h)(3)(D) and Treas. Reg. §1.42-14(h)(2)(i).
Nonprofit Set-Aside: The portion of the state’s housing credit ceiling set aside for projects involving qualified nonprofit organizations so that not more than 90 percent of the state’s credit ceiling is allocated to projects not involving qualified nonprofit organizations. IRC §42(h)(5).
Placed-in-Service Date: The placed-in-service date for a new or existing low-income building is the date on which the first unit in the building is certified as being suitable for occupancy in accordance with state or local law. Generally, this date is documented on the certificates of occupancy. The placed-in-service date for rehabilitation expenditures treated as a separate new building under IRC §42(e)(4)(A) is at the close of any 24-month period, over which such expenditures are aggregated. This placed-in-service date applies even if the building is occupied during the rehabilitation period. Notice 88-116.
Project, Deep Rent Skewed: A low-income project financed with tax-exempt bonds and for which the taxpayer has elected (1) 15 percent or more of the low-income units are occupied by individuals whose income is 40 percent or less of area median gross income; (2) the gross rent for each low-income unit does not exceed 30 percent of the applicable income limit; and (3) the gross rent for each low-income unit does not exceed one half of the average gross rent of units of comparable size which are not occupied by individuals who meet the applicable income limit. IRC §142(d)(4)(B).
Qualified Allocation Plan (QAP): State agencies are required to have a QAP in place for determining which housing projects should receive allocations of IRC §42 credits. The QAP must (1) identify the selection criteria to be used for determining housing priorities that are appropriate to local conditions; (2) give preference to projects serving the lowest income tenants, for the longest periods, and located in qualified census tracts and which will contribute to a concerted community revitalization plan; and (3) provide procedures that the agency (or an agent or other private contractor of such agency) will follow in monitoring for noncompliance with IRC §42 through regular site visits and in notifying the IRS of such noncompliance. IRC §42(m)(1)(B) and Treas. Reg. §1.42-5.
Resident Manager’s Unit: Residential rental unit occupied by a full-time resident manager and treated as a functionally related facility. The adjustment basis of a resident manager’s unit is included in eligible basis, but the unit is excluded from the determination of the applicable fraction and the minimum set-aside. Treas. Reg. §1.103-8(b)(4)(iii) and Rev. Rul. 92-61.
Utility Allowance: A portion of the gross rent. If the tenant pays the utility cost directly to the utility provider, gross rent must include an allowance for the utility. IRC §42(d)(2)(B)(ii) and Treas. Reg. §1.42-10.
Vacant Unit Rule: If a low-income unit becomes vacant, the taxpayer must make reasonable attempts to rent the unit before renting any units to tenants who are not income-qualified. Treas. Reg. §1.42-(c)(1)(ix).