IRS Amends State Agencies' Compliance-Monitoring Requirements

The IRS recently issued final and temporary regulations relating to LIHTC compliance monitoring. The temporary regulations expire Feb. 22, 2019. The amendments revise and clarify the requirement to conduct physical inspections and review low-income certifications and other documentation.

Along with the regulations posted in the Federal Register, the IRS issued Revenue Procedure 2016-15, which sets the minimum number of low-income units at a tax credit site for which a state or local housing agency must conduct physical inspections and low-income certification reviews. It also permits the physical inspection protocol established by HUD’s Real Estate Assessment Center (REAC) to satisfy the physical inspection requirements established by the income tax regulations. The revenue procedure is effective Feb. 25, 2016.

Regulatory Background

The compliance-monitoring regulations describe some of the provisions that must be part of any state agency’s Qualified Allocation Plan (QAP), the standards by which a state or local housing credit agency make tax credit allocations. As part of its compliance-monitoring responsibilities, an agency must perform physical inspections and low-income certification review [26 CFR Section 1.42-5].

The compliance-monitoring regulations specifically provide that, for each low-income housing project, an agency must conduct on-site inspections of all buildings by the end of the second calendar year following the year the last building in the project is placed in service. In addition, prior to amendments, the regulations provided that, for at least 20 percent of the project’s low-income units, the housing agency must both inspect the units and review the low-income certifications, the documentation supporting the certifications, and the rent records for the tenants in those same units.

The regulations provide that the agency must also conduct on-site inspections and low-income certification review at least once every three years after the initial on-site inspection. Further, the regulations require the state or local agency to randomly select which low-income units and tenant records to inspect and review. The regulations also require the agency to choose the low-income units and tenant records in a manner that will not give owners of low-income housing projects advance notice that a unit and tenant records for a particular year will or will not be inspected and reviewed. However, an agency may give an owner reasonable notice that an inspection of the building and low-income units or tenant record review will occur so that the owner may notify tenants of the inspection or assemble tenant records for review (for example, 30-day notice of inspection or review).

Changes to Compliance-Monitoring Regulations

Here are the changes implemented by the final and temporary regulations issued by the IRS:

The 20 percent rule. The final and temporary regulations authorize the IRS to specify in guidance published in the Internal Revenue Bulletin the minimum number of low-income units for which a housing agency must conduct physical inspections and low-income certification review. Revenue Procedure 2016-15, which was issued concurrently with these regulations, provides that, in a low-income housing project, the minimum number of low-income units that must undergo physical inspection is the lesser of 20 percent of the low-income units in the project, rounded up to the nearest whole number of units, or the number of low-income units set forth in our LIHTC Minimum Unit Sample Size Reference Chart.

The revenue procedure applies the same rule to determine the minimum number of units that must undergo low-income certification review. A housing agency is free to conduct physical inspections or low-income certification review on a larger number of low-income units if it believes that to be appropriate.

REAC inspection protocols. The Treasury regulations authorize the IRS to provide in guidance published in the Internal Revenue Bulletin exceptions from, or alternative means of satisfying, the inspection provisions of Section 1.42-5(d).

Revenue Procedure 2016-15 provides that the REAC protocol is among the inspection protocols that satisfy both Section 1.42-5(d) and the physical inspection requirements of Section 1.42-5T(c)(2)(ii) and (iii). According to Revenue Procedure 2016-15, an inspection qualifies as being performed under the REAC protocol only if the inspection satisfies all of the following requirements:

• Both vacant and occupied low-income units in a low-income housing project are included in the population of units from which units are selected for inspection;
• The inspection complies with the procedural and substantive requirements of the HUD Real Estate Assessment Center (REAC), including the requirement to use the most recent REAC Uniform Physical Condition Standards (UPCS) inspection software (or software that is accepted by HUD);
• The inspection is performed by HUD REAC inspectors (or inspectors certified by HUD);
• The inspection results are sent to HUD, the results are reviewed and scored within HUD’s secure system without any involvement of the inspector who conducted the inspection, and HUD makes its inspection report available.

All-buildings requirement. The all-buildings requirement refers to the requirement that housing agencies must conduct on-site inspections of all buildings of a low-income housing project by the end of the second calendar year following the year the last building in the project is placed in service. The regulations continue to require compliance with this requirement. However, Revenue Procedure 2016-15 does provide for an exception.

Under Revenue Procedure 2016-15, the all-buildings requirement does not apply to an housing agency that uses the REAC protocol, under HUD oversight, to satisfy the physical inspection requirement (although the REAC protocol itself may require inspection of all buildings in certain cases). Inspections performed under the REAC protocol or by the Rural Housing Service under the Section 515 program require federal agency oversight. Thus, in the eyes of the IRS, such oversight substitutes for an all-buildings requirement for inspection. Similar to inspections performed by the Rural Housing Service under the Section 515 program, inspections performed under the REAC protocol are not subject to an all-buildings requirement.

Also, a physical inspection that the revenue procedure treats as being performed under the REAC protocol also involves the use of the most recent REAC UPCS inspection software, which has a strong statistical basis. Therefore, under the revenue procedure, the IRS considers the REAC protocol as an acceptable method for satisfying both Section 1.42-5(d) and the physical inspection requirement of Section 1.42-5T(c)(2)(ii) and (iii).

Same-units requirement. The new regulations decouple the requirement that a housing agency must both inspect the units and review the low-income certifications in those same units. Because the units no longer need to be the same, a housing agency may choose a different number of units for physical inspection and for low-income certification review, provided the agency chooses at least the minimum number of low-income units in each case. If an agency chooses to select different low-income units for physical inspections and low-income certification review, the agency must select the units for physical inspection or low-income certification review separately and in a random manner.

Further, because the units no longer need to be the same, an agency may choose to conduct physical inspection and low-income certification review at different times. For example, if HUD requires a physical inspection only two years after a joint HUD/low-income housing credit inspection, that second inspection may be used for both HUD and low-income housing credit purposes without accelerating the next low-income housing credit file review. Also, a housing agency may choose to conduct physical inspections in the summer but complete the low-income certification review in the winter when physical inspections may be difficult to conduct due to weather conditions.

No-notice rule. The final and temporary regulations retain the random-selection rule and strengthen the no-notice rule. Accordingly, if an agency decides to decouple the physical inspection and low-income certification review, the housing agency may not allow selection of a low-income unit for physical inspection (or low-income certification review) to influence the likelihood that the same unit will be selected (or will not be selected) for low-income certification review (or physical inspection).

Whether or not an agency is selecting the same units for inspection and for low-income certification review, the housing agency may give an owner reasonable notice that an inspection of the building and low-income units or review of low-income certifications will occur. This notice enables the owner to notify tenants of the inspection or to assemble low-income certifications for review.

The regulations provide that reasonable notice is generally no more than 30 days, but they also provide a very limited extension for certain extraordinary circumstances beyond a housing agency’s control such as natural disasters and severe weather conditions.

Thus, under the final and temporary regulations, if a housing agency chooses to select the same units for physical inspections and low-income certification review, the agency may conduct physical inspections and low-income certification review either at the same time or separately. However, once the agency informs the owner of the identity of the units for which physical inspections or low-income certification review will occur, the agency must conduct the physical inspections and low-income certification review within the reasonable-notice time frame of 30 days.