Understanding Compliance Requirements of the LIHTC and Tax-Exempt Bond Programs
The owner of a tax credit site you manage may tell you that the site also gets bonds—that is, participates in the tax-exempt bond program. Owners who get approved for these bonds for their site enjoy a tax-exempt status, which means they get lower interest rates on mortgages. They also don’t have to compete with other owners in your state for tax credits. If you manage such a site, you must know how to comply with both programs’ requirements. If you’re not sure what to do, you risk jeopardizing both the owner’s tax credits and its tax-exempt status.
Generally, the same regulations that govern income certifications and verification of income and assets govern LIHTC compliance for a project with bond financing. The bond issuer or state agency that allocates tax credits will expect an owner to follow the same rules for renting a unit at a bond-financed site as it does for any project governed by Section 42 of the federal tax code.
We’ll provide some background on the tax-exempt bond program and identify some compliance areas that may cause confusion when managing a tax credit site that participates in the bond program.
Background on Tax-Exempt Bonds and 4 Percent Tax Credits
Tax-exempt bonds partnered with 4 percent low-income housing tax credits are widely used by affordable housing developers. Using tax-exempt bonds expands the funding sources available for affordable housing. Tax-exempts bonds are debt obligations issued by state or local government agencies for multifamily rental housing, infrastructure improvements, and other qualified municipal endeavors having a public purpose. The Internal Revenue Code (IRC) allows the purchasers of the bonds to deduct the interest income from the bonds from their federal gross income taxes. Thus, the interest rate on tax-exempt bonds is lower than conventional bank financing, and these savings can promote housing affordability.
Another beneficial feature of tax-exempt bonds is that they provide non-competitive 4 percent low-income housing tax credits for sites that meet certain requirements. Typical 9 percent LIHTCs are competitive and limited by the state’s allocation.
Only certain state or local public (or quasi-public) agencies are authorized to issue tax-exempt bonds. In all states, the Housing Finance Agency is authorized to issue tax-exempt bonds for multifamily rental housing, and most major cities have local authorities that can also issue bonds.
Tax-exempt bonds are limited by federal law, often referred to as the “volume cap.” In 2016, as stated by the IRS, the amounts used to calculate the state ceiling for the volume cap for private activity bonds is the greater of $100 multiplied by the state population, or $302,875,000.
In 2016, Texas experienced the largest absolute and percentage increase in population—its population increased by 512,156 residents, an increase of nearly 2 percent. Next in line was Florida, with a 1.9 percent increase in population; California with 0.88 percent; and New York with 0.25 percent. This population growth indicates that LIHTC credit caps will increase by $2.74 million in California, $2.55 million in Texas, $1.88 million in Florida, and $1.1 million in New York.
To qualify for an allocation of 4 percent LIHTCs, 50 percent or more of a site’s development costs must be funded by bonds during construction. The bonds need not come into the project at construction closing, but must be committed to the project before construction is completed.
The compliance period for bond projects (Qualified Project Period) begins the first day on which 10 percent of units are occupied and ends on the later of: (1) the date that’s 15 years after the date on which 50 percent of the units are occupied; (2) the first day on which no tax-exempt private activity bond issued is outstanding; or (3) the date when Section 8 assistance, if any, terminates.
For tax credit sites, the compliance period runs for 15 taxable years beginning with the first taxable year of the credit period. From 1986 to 1989, federal law required developers to maintain these affordability provisions for at least 15 years. Beginning in 1990, however, new LIHTC sites were required to preserve affordability for 30 years. During the first 15 years, called the initial compliance period, owners must maintain affordability. The second 15 years are known as the extended use period, when owners can leave the LIHTC program through a relief process. Once the 15-year affordability period is over, owners who seek and are granted regulatory relief from the program can convert their properties to market-rate units. Some states require longer affordability restrictions, and some LIHTC sites have local financing that comes with longer use restrictions.
Next Available Unit Rule
The Housing and Economic Recovery Act of 2008 (HERA) made the application of the next available unit (NAU) rule to be the same between tax credit sites and tax-exempt bond sites. Previously, the available unit rule was project-wide for tax-exempt bond-financed sites. HERA requires owners with tax-exempt bond financing and tax credits to apply the rule by building.
This means that a low-income unit occupied by a household whose income increases up to 140 percent of the applicable income limitation (or 170 percent of the applicable income limitation for deep rent-skewed projects) continues to be treated as a low-income unit if the household income initially met the income limitation at move-in and the unit continues to be rent-restricted.
Any unit occupied by a household whose income increases beyond 140 percent of the applicable income limitation (or 170 percent for deep rent-skewed projects) is considered to be an “over-income unit.” The unit is considered out of compliance and ceases to be treated as a low-income unit if the next comparable unit that’s available or subsequently becomes available within the building is rented to a non-qualifying household.
The NAU rule defines a “comparable unit” as a unit that’s comparably sized or smaller than the over-income unit (or, for deep rent-skewed projects, any low-income unit).
HERA also stipulated that all tax-exempt bond-financed sites will be governed by the IRC Section 42 student rule. Previously, the only student rule applicable to tax-exempt bond-financed sites was that “a unit shall not be considered to be low and moderate income if all the occupants are students, no one of whom is entitled to file a joint tax return.”
Now, all households at tax-exempt bond-financed sites must certify their household members’ student status. A unit occupied entirely by full-time students will qualify only if the household satisfies one of five exemptions:
- Student receives assistance under Title IV of the Social Security Act (TANF);
- Student is enrolled in a job training program receiving assistance under the Job Training Partnership Act or under similar federal, state, or local laws;
- Student is a single parent with children and the parent is not a dependent of another individual and the children are not dependents of another individual other than a parent or legal guardian;
- Students are a married couple and are eligible to file a joint tax return; and
- Student was at one time a ward of the state (foster child).
You must know how to meet your site’s minimum set-aside so that the site qualifies for both the tax credit and bond programs. For the tax credit program, the owner of a tax credit site chooses the minimum set-aside on a site-wide or building basis. The set-aside tells you the percentage of units that must be rented to qualified, low-income households, as well as the maximum percentage of area median gross income (AMGI) a household can earn to be considered a qualified, low-income household. For instance, if your site’s minimum set-aside is 40-60, it means you must rent 40 percent of your units to households earning no more than 60 percent of AMGI.
At the time the bonds are issued, the project elects to meet either the 20-50 test or the 40-60 test. The 20-50 test means that 20 percent or more of the units in the project are occupied by tenants whose income is 50 percent or less of the area median gross income. The test is met on a project-wide basis rather than on each building as is the basic requirement of IRC Section 42. There is no restriction on the rents that can be charged to the tenants, but if the units are going to qualify as LIHTC low-income units, the more restrictive tax credit requirements must be met.
If the owner elects a different minimum set-aside with the bond-issuing agency than that for the tax credit program, you’ll have to meet two different set-asides at the same time. It’s easy to resolve this conflict because you may count low-income units toward both set-asides. Just rent enough low-income units to meet the higher of your two minimum set-asides. And also make sure that a sufficient number of your low-income households qualify based on the second percentage in both set-asides.
For example, you manage a single-building, 100-unit tax credit site that participates in the tax-exempt bond program. The bond-issuing agency chose 20-50 as the minimum set-aside while the owner chose 40-60. Because you may count low-income units toward both set-asides, you must rent 40 percent of your units to qualified low-income households. You must also make sure that households earning no more than 50 percent of AMGI occupy 20 percent of your units. The remaining 20 percent must be occupied by households earning no more than 60 percent of AMGI.
Because the bond program has no special rent rules unless rent restrictions are outlined in the regulatory agreement, you never have to charge households a lower rent when counting their low-income unit toward two set-asides. In the example above, you may charge rent based on 60 percent of AMGI to the households that earn no more than 50 percent of AMGI (occupying 20 percent of your units). Although these households might actually earn no more than 50 percent of AMGI, for tax credit purposes, you treat them as earning no more than 60 percent of AMGI.
An owner must complete a separate 8703 form annually for every site financed through the tax-exempt bond program. The owner provides information on unit turnover, and certifies its compliance with the minimum set-aside and the deep rent-skew election, where applicable. In Section III of the form, the owner provides information on the bond issuer and the specific bond issue that provided the financing for the project. The form is due to the IRS annually by March 31. IRC Section 6652(j) provides for a penalty of $100 for each failure to comply.
For tax credit sites, owners must file IRS Form 8609 the first credit year. Form 8609 is issued by the State Housing Credit Agency to allow owners to obtain housing tax credits and to certify other necessary information. Owners obtain at least one Form 8609 for each building beginning the year credits are claimed. Form 8609 is filed once with the IRS, and Form 8609-A (Annual Statement for Low-Income Housing Credit) is filed annually throughout the 15-year compliance period.
For household transfers in the tax-exempt bond program, a transfer from one unit to another, even in the same building or to another building within the same project, must always be treated as a new move-in. The household must qualify for the new unit based on the current applicable income limit as of the transfer’s effective date.
For sites that utilize tax-exempt bond financing and tax credits, the less restrictive tax credit rule applies.
Transfers within the same building. When a current qualifying household in a tax credit unit transfers to another unit within the same building, the newly occupied unit adopts the status of the vacated unit and the vacated unit adopts the former status of the newly occupied unit. In other words, the two units swap their status with one another. The result is that the household simply transfers and is not required to be certified as a new move-in.
Transfers to another building. When a current qualifying household transfers to a unit in another building within the same project, the newly occupied unit adopts that status of the vacated unit and the vacated unit adopts the former status of the newly occupied unit provided the household’s income does not exceed 140 percent of the current income limit upon transfer. To determine whether your buildings are treated as individual projects or as one multiple building project, you can refer to your site’s first-year IRS Form 8609 (Part II).