Overview of State Agencies' Compliance Monitoring Requirements
The Low Income Housing Tax Credit (LIHTC) program is the country’s most extensive affordable housing program. The program was added to Section 42 of the Internal Revenue Code (IRC) in 1986 to provide private owners with an incentive to create and maintain affordable housing. The LIHTC program works through a subsidy mechanism. The Internal Revenue Service (IRS) allocates funds on a per-capita basis to each state. And each state has a housing finance or other agency that assumes responsibility for allocating tax credits to developers. The process by which the states allocate the credits is competitive and uses criteria enumerated in the state’s Qualified Allocation Plan (QAP).
Under IRC Section 42(m)(1), the state agency must develop a QAP that’s approved by the governmental unit having jurisdiction over the state allocating agency. The QAP must:
- Identify the selection criteria to be used for determining housing priorities that are appropriate to local conditions. The selection criteria must include project location, housing needs characteristics, project and sponsor characteristics, tenant populations with special needs, public housing waiting lists, tenant populations of individuals with children, projects intended for eventual tenant ownership, the energy efficiency of the project, and the historic nature of the project; and
- Give preference to projects serving the lowest income tenants, for the longest periods, located in qualified census tracts, and which will contribute to a concerted community revitalization plan.
In addition to assuming responsibility for allocating tax credits, state agencies are also responsible for compliance monitoring. Compliance monitoring regulations require state agencies to make site inspections and require owners to certify to their state agencies that their sites were in compliance with the requirements of IRC Section 42. We’ll provide an overview of the state agencies’ responsibilities while monitoring LIHTC sites throughout the compliance period.
Under Treasury Regulation Section 1.42-5(c), owners are required to annually certify that their sites were in compliance with IRC Section 42 for the preceding 12-month period. They must report in the form and manner the agency specifies and must certify, under the penalty of perjury, that the information provided is true, accurate, and in compliance with the requirements of IRC Section 42.
Treasury Regulation Section 1.42-5(c)(1) lists 12 specific requirements that must be addressed in the certification. These requirements are identified in “Meet Requirements of Annual Certifications to the State Housing Agency,” in this issue.
The state agencies are required to review the certifications. And the owner is considered to be in noncompliance if the certification is inaccurate, incomplete, or the owner discloses noncompliance with any IRC Section 42 requirement.
Treasury Regulation Section 1.42-5(c)(2)(ii) requires state agencies to physically inspect a randomly selected sample of low-income rental units by the end of the second calendar year following the year the last building in the project is placed in service and then, on an ongoing basis, at least once every three years. The purpose is to confirm that the rental units are suitable for occupancy [IRC §42(i)(3)(B)(ii)].
If you manage a multi-building site and your state agency hasn’t adopted HUD Real Estate Assessment Center (REAC) physical inspection protocols, all LIHTC buildings must be inspected by the end of the second calendar year in which the last building at your site was placed in service.
If your state agency, however, has adopted REAC protocols, it doesn’t have to inspect all LIHTC buildings. In the eyes of the IRS, HUD’s oversight of the REAC program substitutes for an all-buildings requirement for inspection.
The frequency of inspections under the REAC protocol is based on inspection scores. But even with an outstanding score, inspections performed under this protocol are required at least once every three years. REAC scores are based on a scale of 0-100 that reflects the physical condition of a property, inspectable area, or sub-area. A passing score is 60 or above, and your most recent score will determine when your next inspection will occur. A score of 90 to 100 means your next inspections will occur in three years; 80 to 89 is every two years; and 79 and below means your site will be inspected every year under the REAC protocol.
According to IRS Revenue Procedure 2016-15, state housing agencies must inspect the lesser of 20 percent of your site’s low-income units, rounded up to the nearest whole number of units, or the number of low-income units set forth in the Low Income Housing Credit Minimum Unit Sample Size Reference Chart found in the Revenue Procedure. But your agency can inspect more—or even all—of your units, if it chooses to.
Tenant File Reviews
Treasury Regulation Section 1.42-5(c)(2)(ii) also requires agencies to review the tenant to confirm that the appropriate rental units are occupied by income-qualified households.
This year, one important change with the issuance of Revenue Procedure 2016-15 is the decoupling of the requirement that your 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, your state agency may choose a different number of units for physical inspection and for low-income certification review, provided that the agency chooses at least the minimum number of low-income units in each case.
Compliance Review with Other LIHTC Requirements
The agencies must also consider the taxpayer’s compliance with other requirements under IRC Section 42 such as rent restrictions, the general public use rule (units provided are consistent with federal housing policy governing nondiscrimination as determined under HUD rules and regulations), the next available unit rule, the unit vacancy rule, and utility allowances.
Annual IRC Section 42(l)(3) Report
Under IRC Section 42(l)(3), agencies submit an annual report to the IRS specifying the amount of credit allocated during the year, information about the building receiving the allocation and the owner of the building, and information about the agency’s compliance with IRC Section 42 requirements.
State agencies satisfy this reporting requirement by filing Form 8610, Annual Low-Income Housing Credit Agencies Report. Section III of this form, Part III has questions addressing the agency’s compliance monitoring activities for that year and specific compliance monitoring requirement based on when the low-income buildings were placed in service.
The report is due Feb. 28 of the following year and is signed by the state agency’s official under penalties of perjury.
Compliance Monitoring Timeline
Here’s a compliance monitoring timeline to which state agencies will generally follow:
Notice of inspection. As a practical matter state agencies provide taxpayers with advance notice of an upcoming inspection/review so that the taxpayer can notify tenants and assemble tenant records. According to the IRS’ Guide for Completing Form 8823, Low-Income Housing Credit Agencies Report of Non-compliance, a state agency should accommodate an owner’s valid need to reschedule a site visit or tenant file review, but should not allow owners to delay or circumvent compliance monitoring reviews. The IRS recommends that if the site visit/file review can be rescheduled within 45 days of the initial date, the appointment should be rescheduled; longer postponements should be discouraged except under unusual circumstances. However, the IRS notes that there is no legal authority for allowing this time period; it’s similar to IRS policy for rescheduling audit appointments during an audit.
Inspection/reviews. State agencies conduct inspections/reviews to confirm continuous compliance with IRC Section 42 or to identify currently existing noncompliance.
Notifications of inspection/review results. Once the inspection/review is completed, the agency must promptly provide the taxpayer with a written notice if the IRC Section 42 project is not in compliance. Examples include: the taxpayer didn’t submit its annual certification; the agency wasn’t allowed to review the tenant files; or the agency discovers by inspection, review, or in some other manner, that the project is not in compliance. Many state agencies also provide notice to close the inspection/review when no noncompliance issues are discovered.
Correction period. The date of the agency’s notice to the taxpayer starts the correction period during which the taxpayer can resolve any noncompliance issues identified by the agency. The correction period isn’t defined by regulation, but is not to exceed 90 days. State agencies also have authority under Treasury Regulation 1.425(e)(4) to extend the correction period to a total of six months, but only if the agency determines there’s good cause for doing so.
Reporting noncompliance to the IRS. Regardless of whether the noncompliance is corrected within the designated correction period, agencies must report any observed noncompliance to the IRS within 45 days after the end of the correction period. Form 8823, Low-Income Housing Agencies Report of Noncompliance or Building Disposition, is used to report noncompliance to the IRS.
The state agency must explain on Form 8823 the nature of the noncompliance or failure to certify and indicate whether the owner has corrected the noncompliance or failure to certify. Any change in either the applicable fraction or eligible basis that results in a decrease in the qualified basis of the project under Section 42(c)(1)(A) is noncompliance that must be reported to the IRS. If the agency reports on Form 8823 that a building is entirely out of compliance and won’t be in compliance at any time in the future, the state agency need not file Form 8823 in subsequent years to report that building’s noncompliance. If the noncompliance or failure to certify is corrected within three years after the end of the correction period, the state agency is required to file Form 8823 with the IRS reporting the correction of the noncompliance or failure to certify.
The state agency must retain records of noncompliance or failure to certify for six years beyond the state agency’s filing of the respective Form 8823. In all other cases, the state agency must retain the certifications and records described above for three years from the end of the calendar year the state agency receives the certifications and records.