IRS Issues Final Rule on Physical Inspections and Compliance Monitoring
On Feb. 26, the IRS issued final regulations for LIHTC compliance monitoring. The regulations replace the temporary compliance monitoring regulations under which state housing agencies have been operating since 2016. The new regulations make several changes to compliance monitoring requirements, including in some cases increasing the number of units in a property that housing agencies will need to monitor. The final regulations became effective immediately.
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 makes 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 the 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 won’t give site owners 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.
Temporary Regulations, Revenue Procedure 2016-15
Before the final regulations were issued, the following rules were in effect:
The 20 percent rule. The IRS specified 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 provided 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 the LIHTC Minimum Unit Sample Size Reference Chart.
The revenue procedure applied the same rule to determine the minimum number of units that must undergo low-income certification review. This review concerns a site’s certification that occupants of LIHTC units have incomes at or less than 60 percent or 50 percent of the area median (AMI), and that those residents pay rents no greater than 30 percent of 60 percent of AMI or 30 percent of 50 percent AMI, depending on the designation selected by the owner.
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. Revenue Procedure 2016-15 provided 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 qualified as being performed under the REAC protocol only if the inspection satisfied 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 REAC procedural and substantive requirements, 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.
However, Revenue Procedure 2016-15 provided an exception. Under Revenue Procedure 2016-15, the all-buildings requirement doesn’t apply to a 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.
Same-units requirement. The temporary regulations decoupled 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 could choose a different number of units for physical inspection and for low-income certification review, provided the agency chose at least the minimum number of low-income units in each case. If an agency chose to select different low-income units for physical inspections and low-income certification review, the agency had to 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 could choose to conduct physical inspection and low-income certification review at different times. Also, a housing agency could 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. If an agency decided to decouple the physical inspection and low-income certification review, the housing agency could not allow selection of a low-income unit for physical inspection (or low-income certification review) to influence the likelihood that the same unit would be selected (or would not be selected) for low-income certification review (or physical inspection).
Whether or not an agency selected the same units for inspection and for low-income certification review, the housing agency had to provide reasonable notice that an inspection of the building and low-income units or review of low-income certifications would occur. This notice enabled the owner to notify tenants of the inspection or to assemble low-income certifications for review.
The regulations previously provided that reasonable notice is generally no more than 30 days, but they also provided a very limited extension for certain extraordinary circumstances beyond a housing agency’s control, such as natural disasters and severe weather conditions.
The final regulations make some significant changes to how state housing agencies will monitor tax credit sites. According to the final regulations, the following changes must be implemented no later than Dec. 31, 2020. This is done by housing agencies amending their QAP to include the requirements of this final regulation. When the QAP is amended, Revenue Procedure 2016-15 will be considered obsolete. QAPs must be amended by Dec. 31, 2020.
Minimum number of units. The final rule requires housing agencies to inspect at least as many units as specified by project size in the Low Income Housing Credit Minimum Unit Sample Size Reference Chart [§1.42-5(c)(2)(iii)]. Previously, the temporary regulations allowed agencies to inspect the lesser of 20 percent of the total number of units or the number of units in the Minimum Unit Sample Size Reference Chart. Agencies may inspect more units than the minimum requirement at their discretion.
All buildings rule. The final regulations maintain the “all buildings” rule, which requires agencies to conduct on-site inspections in units in all buildings in a project, rather than simply applying the minimum unit sample size on a project-wide basis if a project encompasses multiple buildings. The only exception that the IRS made to the all buildings rule is to allow agencies that use the REAC protocol to satisfy the physical inspection requirement to follow the REAC protocol even when it doesn’t require inspections in all buildings. The IRS notes, “The REAC protocol requires that the inspectors be specially trained in its use. When an Agency is not using that protocol, it may choose inspectors of diverse expertise to conduct inspections. The quality of these inspections may vary across projects and jurisdictions…. In the absence of HUD oversight, requiring that all buildings be inspected serves as a quality control mechanism.”
Notice requirement. The final regulations shorten the reasonable notice requirement to 15 days in advance of when a site will experience a physical inspection or review of low-income certification, down from a 30-day notice requirement under the temporary regulations. A housing agency may notify the owner of the particular low-income units for inspection only on the day of the inspection.
The notice period begins on the date the housing agency informs the owner that a site inspection of a project and low-income units or low-income certification review will occur. Notice of more than 15 days, however, may be reasonable in extraordinary circumstances that are beyond an agency’s control and that prevent an agency from carrying out within 15 days an on-site inspection or low-income certification review.
Extraordinary circumstances include, but are not limited to, natural disasters and severe weather conditions. In the event of extraordinary circumstances that result in a reasonable-notice period longer than 15 days, an agency must select the relevant units and conduct the same-day on-site inspection or low-income certification review as soon as practicable.
Random unit selection. The housing agency must select in a random manner the low-income units to be inspected and the units whose low-income certifications are to be reviewed. Agencies generally may not select the same low-income units of a site for on-site inspections and low-income certification review, because doing so would usually give prohibited advance notice, unless they are done on the same day.
A housing agency may choose a different number of units for on-site inspections and for low-income certification review, provided the agency chooses at least the minimum number of low-income units in each case. And the agency must select the units for inspections or low-income certification review separately and in a random manner.
REAC protocol. A housing agency may choose to use the REAC protocol to meet its physical inspection obligation if the inspection is conducted by HUD or a HUD-certified REAC inspector. But the housing agency must still review a project’s compliance with the LIHTC maximum income and rent requirements.