Perform End-of-Year Review to Verify Compliance

As the holiday season approaches, we know that audit season isn’t far behind. Taking steps now to review management practices, household files, and preparing annual forms will help ensure a strong start to the upcoming year and an efficient audit process.

The following is a list of year-end items that owners or managers may review now to ensure deadlines are met and to minimize disruptions to day-to-day operations.

[] Review Recent Data on Vacant Units and Marketing Materials

Annual owner reports are completed with information as of year-end. For units that are vacant at year-end, make sure you have complete data for the previously qualified household, including move-in information and, if you have a mixed-income site, information from the last recertification performed, and the move-out date.

Vacant units at a mixed-income project are very important for owners to monitor, as any over-income units in the building will trigger the available unit rule, even if vacated after going over-income. The available unit rule allows the owner to continue claiming credits on the over-income unit as long as all subsequent vacant units (that are comparable or smaller) are rented to qualified households, until the required applicable fraction is restored. If the owner fails to rent comparable or smaller units to qualified households, it causes all larger over-income units in the building to fall into noncompliance.

You should also review your site’s advertising and marketing materials. One beneficial rule under Section 42 is the vacant unit rule. This allows credits to be claimed if a qualified household moves out of a low-income unit and with reasonable attempts to rent the unit, it stays vacant. So when an LIHTC unit goes vacant, the next unit (of comparable or smaller size) must be rented to an LIHTC eligible household, even if it was previously a market unit. The vacant unit rule is violated if there is no marketing, the units are offline, or if the unit is rented to an ineligible household.

You can prove you’re making reasonable attempts to rent LIHTC units by keeping records of your marketing materials. If you place ads in local newspapers and on the radio, flyers, and the Internet, keep all these marketing materials along with a log of when the marketing was active. For more information on the vacant unit rule, see “Follow Five Dos & Don'ts to Comply with the Vacant Unit Rule.”

[] Review Household Files

Review all new move-in files before the end of the taxable year for completeness. If your site is 100 percent tax credit and no longer recertifies families (except for student status), compliance rests on the status of the household file when the family moved in. Check that your new move-ins from the past year prove eligibility.

If you find a mistake in a household file, trying to fix the error is just half the job. You should also draft a memo to the file telling potential auditors what you did. Your memo to the file should cover the date you found the problem; the nature of the problem; what you did to try to fix it; and how you plan to prevent the mistake from recurring.

For more information, see “How to Set Up Household Files to Save Time and Avoid Tax Credit Recapture.”

[] Ensure Recertifications Are Current

If your state’s housing authority requires recertifications at your site, be sure all are current and if not, be sure the recertification is completed before the end of the year. Generally speaking, if you manage a mixed-income site, you and your staff must recertify all low-income households at the site each year. Failing to meet recertification requirements is a leading cause of noncompliance that can cost the owner its tax credits.

Make sure you’ve followed up on all income or asset discrepancies found during recertifications and be sure there’s a written memo documenting your investigation into a discrepancy by writing a short clarification memo to the household file. Describe the discrepancy and the explanations given by the household member and the verification source. This way, you can show your state housing agency what steps you took to resolve the discrepancy if a question arises during an audit.

For more tips on recertifying households more efficiently, see “Follow Seven Tips When Recertifying Households at Mixed-Income Sites.”

[] Prepare Owner’s Annual Certification Forms

Under Treasury Regulation Section 1.42-5(c)(1), owners are required to certify to the state agency that allocated the credit at least annually that, for the preceding 12-month period, the site was operated in compliance with Internal Revenue Code (IRC) Section 42 requirements. Most state agencies define “annual period” as the calendar year, with due dates for submission.

Once submitted, the state agencies review the certifications. And the owner is considered to be in noncompliance if the certification is inaccurate or incomplete, or if the owner discloses noncompliance with any of the 12 specific requirements listed in the certification.

Even though the certification is made to the state agency, failure to complete the annual certification is reportable to the IRS on Form 8823, Low-Income Housing Credit Agencies’ Report of Noncompliance or Building Disposition, line 11d. Some of the common problems reported to the IRS are:

• The certification is incomplete. The owner didn’t certify compliance with a specific IRC Section 42 requirement.
• The certification isn’t signed, which means there is not a “certification.”
• For nonresponsive owners, usually after sending reminders to the owner, the state agency will report that the certification hasn’t been received.

The IRS views the annual certification, even if self-prepared, as credible evidence of compliance with specific IRC Section 42 requirements. For more information, see “Meet Requirements of Annual Certification to State Housing Agency.”

[] Review Rents and Other Charges

Check to make sure there has been no change in the applicable fraction from the prior year. The applicable fraction is the percentage of a building dedicated to low-income residential rental units. Under IRC Section 42(c)(1)(B), the applicable fraction is the smaller of the unit fraction or the floor space fraction.

If you rent a unit to a qualified low-income household, the rent charged must be restricted. If you charge more than the maximum, the IRS won’t consider that unit low income and you can’t count it as such in your building’s monthly applicable fraction.

The maximum rent you can charge is based on 30 percent of the appropriate income limit for your area. After you calculate a unit’s gross rent, subtract its utility allowance to get the “maximum allowable rent.” This is the highest monthly rent you can actually charge households. If you charge an amount that’s equal to or less than the maximum allowable rent for a unit, you’ll satisfy this third condition for counting that unit as low income in your building’s monthly applicable fraction.

It’s important to note that non-optional fees related to services other than housing or as a condition of occupancy must be included in the gross rent [Treas. Reg. §1.42-11]. A service is optional when the service is not a condition of occupancy and there is a reasonable alternative. Charges for non-optional services such as a washer and/or dryer hookup and built-in/on storage sheds (paid month to month or in a single payment) would always be included within gross rent.

No separate fees should be charged for tenant facilities such as pools, parking, or recreational facilities if the costs of the facilities are included in the site’s eligible basis. Assuming they are optional, charges such as pet fees, laundry room fees, garage fees, and storage fees may be charged in addition to the rent.

Under Treasury Regulation Section 1.42-11(a)(3), the cost of services that are required as a condition of occupancy must be included in gross rent even if federal or state law requires that the services be offered to tenants by building owners. Refundable fees associated with renting an LIHTC unit are not included in the rent computation. For example, security deposits and fees paid if a lease is prematurely terminated are one-time payments that are not considered in the rent calculation.

However, required costs or fees, which are not refundable, are included in the rent computation. These include fees for month-to-month tenancy and renter’s insurance. For more information on which units to count as low income, see “Check for Five Conditions to Count Unit as Low Income in Monthly Applicable Fraction.”

[] Review Utility Allowances

Your residents are entitled to a utility allowance if they are responsible for payment for their gas, electric, water, sewer, or trash service. A unit is out of compliance if you are not crediting the resident with a utility allowance, and the amount you charge him for rent exceeds the tenant rent calculated when subtracting the correct utility allowance from the maximum allowable rent.

To properly calculate the rents you charge your low-income households, you must use correct utility allowances. If you use an incorrect utility allowance, you’ll end up charging a household too much or too little rent. If you charge too much for a unit, it will fall out of compliance, placing the owner’s tax credits at risk. If you charge too little, your mistake will cost the owner in lost rent revenue.

For more information on using the correct source for your utility allowances, see “How to Identify Correct Utility Allowances to Use at Your Site.”

[] Make First-Year Certification, If Applicable

Taxpayers owning IRC Section 42 housing 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 certification is made by completing Part II of the Form 8609, Low-Income Housing Credit Allocation and Certification, with Part I executed by the state housing agency. The completed certification is submitted, one time, to the IRS.

For more details on the information needed to fill out the form, see “How to Comply with IRC Section 42(l)(1), First-Year Certification.”