Include Required LIHTC Documents in Site's Retention Plan
Every year site owners submit various IRS tax forms to claim the low-income housing tax credit on their tax return. IRS examiners look at the submitted information along with internal IRS information to determine whether to conduct an audit. If an examiner wants to continue with the audit process, the examiner will send a notice by mail. The letter will include a request for information and list documents to be made available for the audit. The request for information is known as an IDR, which stands for Information Document Request. An IDR is issued on IRS Form 4564.
In many tax audits the IRS will issue an IDR at the beginning of the audit and then issue additional IDRs as the case progresses. The IRS has broad authority when it makes an IDR. Internal Revenue Code (IRC) Section 7601 empowers IRS employees to “inquire after and concerning all persons who may be liable for any internal revenue tax.” IRC Section 7602 also authorizes the IRS to examine any books, materials, data, or papers that may be relevant material.
We’ll discuss the forms whose information may raise concerns with IRS examiners and trigger an audit. Also, we’ll discuss an owner’s recordkeeping and record retention responsibilities. And we’ll go over items you might expect to see on the first IDR for the audit of a taxpayer owning an LIHTC site.
Owner-Submitted IRS Forms
In addition to annual certifications, owners are required to complete a “First-Year Certification” under IRC Section 42(l)(1). The certification is made to identify specific information needed for the administration of the program and document specific elections that will govern how the site is operated. The following forms are filed with a site ownership’s tax return, except for Form 8823.
Form 8609. Making the certification involves Form 8609, Low-Income Housing Credit Allocation and Certification. The agency executes Part I and then mails the Form 8609 to the owner. The owner then completes the certification required under IRC Section 42(l)(1) for the first year of the credit period by completing Part II of the Form 8609 and submitting it, one time, to the IRS.
Part I of Form 8609, completed and signed by the state agency, documents approval of the finished low-income housing building and identifies the amount of the allowable annual low-income housing tax credit.
Naturally, tax credit owners want to start claiming the credits state housing agencies have allocated to them as soon as possible. But in a rush to start claiming credits, some owners may claim tax credits before their state housing agency issues the IRS Form 8609. Owners may file tax returns with only Part II of Form 8609 attached with an explanation that the owner has provided the state agency with all the information necessary for the state agency to make a final determination of the credit amount.
The IRS takes this seriously. To the IRS, there’s always the possibility that an owner is fraudulently claiming the credit. Further, even if the taxpayer has entered into a contract with the state agency, the IRS has no way of knowing that the state agency has approved the completed project, the amount of credit the owner is entitled to claim, or the terms of the allocation until the taxpayer completes the IRC Section 42(l)(1) certification. Claiming credits too soon or failing to provide a reasonable cause will result in the disallowance and/or recapture of tax credits.
Form 8609-A. Building owners file this form to report compliance with the low-income housing provisions for each year of the 15-year compliance period and calculate the low-income housing credit. A separate Form 8609-A is required for each allocation, so there is a one-to-one match of Forms 8609 and Forms 8609-A.
Form 8586. Form 8586 summarizes key information from the Forms 8609-A. It’s a Low-Income Housing Credit Attachment. One form is filed with the IRS annually while credit is being claimed. The form shows the amount of credit claimed for the entire project during the specified year.
Form 8823. State and local housing credit agencies are responsible for monitoring LIHTC sites for compliance with the requirements of IRC Section 42—for example, health and safety standards, rent ceilings and income limits, and tenant qualifications. State agencies perform desk audits, inspect housing, and review tenant files. When noncompliance is identified or the state agency becomes aware of a disposition of a building, the state agencies are required to notify the IRS using Form 8823, Low-Income Housing Credit Agencies Report of Noncompliance or Building Disposition.
Owner’s Recordkeeping and Record Retention Responsibilities
IRS regulations specify the tax credit recordkeeping and record retention provisions that owners must follow to maintain compliance [26 CFR Part I - 1.42-5(b)]. The LIHTC program requires owners to maintain site records in accordance with program requirements and to provide annual reports to their monitoring agency documenting the site’s occupancy.
An owner must keep records for each qualified low-income resident by building and unit number throughout the site’s compliance period. Owners must keep records for tenant files, tracking data for units on a monthly basis, and site files, which include records regarding the use of facilities included in the site’s eligible basis. Owners must also retain compliance certifications, annual LIHTC status reports, and a qualified basis tracking sheet each year until the site original qualified basis is established.
The owner must retain the above-described records for the first year of the credit period for at least six years beyond the due date (with extensions) for filing the federal income tax return for the last year of the compliance period, meaning original files must be retained for 21 years. All other records are required to be retained for at least six years after the due date (with extensions) for filing the federal income tax return for that year.
Preparing for Information Document Requests
The following is a wide-ranging list that IRS auditors of an LIHTC site may request for the initial IDR. Auditors will shape the request depending on the facts of the case. It’s important to note that there may be follow-up IDRs after you’ve submitted the initial package of documents.
- Partnership Agreement;
- Prospectus/Offering Memorandum related to the organization or syndication of the partnership;
- Documentation for the partners’ capital contributions and current balance;
- Credit Allocation Application;
- Market Study;
- Credit Allocation Award or Carryover Allocation;
- Extended Use Agreement;
- All Forms 8609 issued to the owner; and
- Internal audit reports.
- Copies of tax returns for the tax year prior to the earliest year under audit, and all tax returns for years subsequent to the tax years under audit;
- Trial balance and any work papers used to prepare the tax return under audit; and
- Depreciation schedules.
- Final cost certification submitted to the state allocating agency with supporting documentation;
- Documentation of all financing sources;
- Development contracts or agreements;
- Documentation of cost allocations between land, nonqualifying land improvements, and depreciable residential rental property included in eligible basis.
- For the years under audit, rent rolls identifying the households and family size for each low-income unit;
- Documentation of internal controls in place to ensure that income-qualified households occupy the low-income units.
First and 11th Year of the Compliance Period
If the first year of the compliance period is audited, the special rule for computing the applicable fraction under IRC Section 42(f)(2) is used. The owner should provide:
- Certificates of Occupancy;
- A schedule indicating when each low-income unit was first occupied by an income-qualified household; and
- Computation of First Year Applicable Fraction, including the computation of the applicable fraction on a monthly basis.
If the 11th year of the compliance period is audited and the owner has claimed credit, the owner should provide the information identified above as well as a copy of the tax return for the first year of the credit period.
Additions to Qualified Basis
- A list of units first occupied by qualifying tenants after the end of the first year of the credit period identifying when a qualifying household first occupied the unit; or
- Confirmation that all units were occupied by qualifying household by the end of the first year of the credit period.
Rents and Other Sources of Income or Funds
- Description of residential rental units, including total number of units, total number of low-income units, size (bedrooms), and rents charged for low-income and market-rate units;
- Documentation that rents are correctly restricted;
- Sources of rent subsidies;
- Documentation for computation of any utility allowances;
- Fees for services provided to tenants in addition to housing;
- Other income from related activities such as vending machines, laundry facilities, etc.;
- Other income from sources such as commercial use of a portion of the property; and
- Documentation of funds received from other sources such as federal grants or subsidies received during the year, additional capital contributions, or loan proceeds.
If the audit resulted from the filing of Forms 8823 by the state agency, the owner should provide documentation for corrective actions taken to restore the site to compliance.
If the site was sold, the IRS will request documentation regarding the sale. Requested documentation will include the sales contract and settlement documents, computation of the capital gain/loss, how the gain/loss was distributed among the partners, and whether the sale required the new owner to operate the site as a qualified low-income project for the remainder of the 15-year compliance period.