TRA86 adversely affected many investment incentives for rental housing while leaving incentives for home ownership. Since low-income people are more likely to live in rental housing than in owner-occupied housing, this would have decreased the new supply of housing accessible to them. The Low Income Housing Tax Credit was hastily added to TRA86 to provide some balance and encourage investment in multifamily housing for the poor. Over the subsequent 20 years, it has become an extremely effective tool for developing this housing. As of 2006, as much as 30 to 40% of all new multifamily construction has received a subsidy under the program. The estimated cost to the federal Treasury in FY05 was $3.85 billion. The annual allocations under the program increased significantly in 2001 when Congress increased the state allocations by 40%. A majority of tax credit projects also receive subsidies from other government sources. These additional subsidies, which can include development grants and loans at below-market interest rates from local and state governments, can account for a third of total capital subsidies. Thirty-nine percent of low-income tenants also receive rental assistance in the form of housing voucher from HUD's Section 8 program. Though common, these are not necessarily present in a project that benefits from the LIHTC.
How it Works
The first step in the process is for a project owner to submit an application to a state authority, which will consider the application competitively. The application will include estimates of the expected cost of the project and a commitment to comply with either of the following conditions, known as "set-asides": At least 20% or more of the residential units in the development are both rent restricted and occupied by individuals whose income is 50% or less of the area median gross income. At least 40% or more of the residential units in the development are both rent restricted and occupied by individuals whose income is 60% or less of the area median gross income. Typically, the project owner will agree to a higher percentage of low income usage than these minimums, up to 100%. Low income tenants can be charged a maximum rent of 30% of the maximum eligible income, which is 60% of the area's median income adjusted for household size as determined by HUD. There are no limits on the rents that can be charged to tenants who are not low income but live in the same project.
The program is administered at the state level with each state getting a fixed allocation of credits based on its population. The state housing agency has wide discretion in determining which projects to award credits, and applications are considered under the state's "Qualified Allocation Plan" (QAP). The credits are usually awarded to projects in a few "allocation rounds" held each year, on a competitive basis. Typically, the top ranked project will get credits, then the second, and so on until the credits are exhausted for the round. A portion of each state's credits must be "set aside" for projects sponsored by non-profit organizations, although non-profits more typically apply for credits under the "general" rules, without regard to the set-aside. This allows each state to set its own priorities and address its specific housing goals. It also encourages developers to offer benefits that are better than the established minimums when competing against other projects (e.g., charging lower rents, or maintaining the low income requirements for a longer number of years, will often improve a project's rank in the competitive process; it is important to check the particular state's QAP and application to see how it makes these judgments). Not all projects claim the low income credit based on this competitive process. Projects that are financed by tax-exempt bonds can also qualify for the credit. Tax-exempt bonds are also limited on a state-by-state basis, and the state agency responsible for bonds may be different, but it will generally apply similar rules than the agency responsible for the tax credit program.
Terms and Conditions
The "eligible basis" of a project is the cost of acquiring an existing building if there is one (but not the cost of the land), plus construction and other construction-related costs to complete the project. (For example, the costs of obtaining permanent financing, or "syndicating" the credits to an investor are not included. Adjustments must be made for federal grants as well). This is then multiplied by the percentage of the units that are "low income", in accordance with the conditions described above, to determine the project's "qualified basis" that actually qualifies for the credit. For this reason, many developers agree to make 100% of the units low income in order to maximize the potential tax credits. Projects for (1) new construction and (2) the cost of rehabilitating an existing building, if not funded by tax-exempt bonds or "below market federal loans", can receive a maximum tax credit allocation of approximately 8% to 9% of the project's eligible basis annually. The cost of acquiring an existing building (but not the land), provided the building was (in general) last "placed in service" at least ten years earlier, and projects financed in whole or in part with tax-exempt bonds or below market federal loans, are eligible for a credit of approximately 3 to 4% annually. The credit percentages are announced monthly by the Internal Revenue Service.
The project owner must agree to comply with Section 42 and maintain an agreed percentage of low income units in a "Land Use Restriction Agreement" (LURA) which is recorded. Under the LURA, the project is required to meet the particular project's low income requirements for a 15-year initial "compliance period" and a subsequent 15-year "extended use period" (or longer, if required by the local authority; the extended use rules were added in 1989, and do not apply to projects developed in the first few years of the program.) The credits are subject to "recapture" if the project fails to comply with the requirements of Section 42 of the Tax Code during the 15-year compliance period.
Regardless of the result of these computations, the credit cannot exceed the amount allocated by the state agency. For example, suppose a project cost $100,000 for land, $400,000 for an existing building that was most recently placed in service more than 10 years ago, and $1,000,000 for rehabilitation; also suppose that the applicable percentages are 8.5% and 3.5%, that the project will be 80% low income, that there are no tax-exempt bonds or below market federal loans, and that the state agency awarded $70,000 per year of credits. The credits are computed as follows -- (1) the cost of the land is not eligible for credits; (2) the maximum annual credit for the purchase of the building is $400,000 times 80% times 3.5%, or $11,200; (3) the maximum annual credit for the rehabilitation is $1,000,000 times 80% times 8.5%, or $68,000. The total maximum annual credits, $79,200, is more than the amount of credits awarded by the state. As a result, the project is limited to $70,000 of credits per year. The credits are not provided in a lump sum but instead are claimed in equal amounts over a 10 year "credit period" (many projects claim credits over 11 years, due to the rules governing how many credits can be claimed in the first year of the credit period). Thus, the $70,000 of annual credits described in the illustration will yield a total of $700,000 of credits over the credit period.
Syndication and Partnership
As mentioned above, the credit is used to generate private equity, often prior to, or during, the construction of the project. Developers typically "sell" the credits by entering into limited partnerships (or limited liability companies) with an investor, with 99.99% of the profits, losses, depreciation, and tax credits being allocated to the investor as a partner in the partnership. The developer serves as the general partner/managing member, and receives a majority of the cash flow (either through the payment of fees, or through distributions). The funds generated through the syndication vary from market to market and year-to-year. Although 85-95¢ for each total dollar of tax credits was common in the first several years of the 21st century, recent turmoil in the financial markets has reduced some of the demand for tax breaks, meaning that investors are paying somewhat less, as of early 2008. So, for example, $10,000 credits annually for the next 10 years would be $100,000 total, and a developer could probably raise $75,000-$85,000 through syndication, which is less than could have been raised for the few years prior to 2008. Further, due to the fact that depreciation on the buildings owned by the partnership is also tax deductible, and that depreciation is allocated 99.99% to the investor, investors may pay still more for the total tax benefits. (Indeed, when the credit alone was selling for 95 cents per dollar of credit, there were some cases where investors actually paid slightly more than a dollar for a dollars worth of tax credits plus other tax benefits.) An investor will typically stay in the partnership for at least the compliance period, because a reduction in its interest can also result in recapture of the credits. An investor wishing to exit the partnership before the end of the compliance period may post a surety bond to avoid credit recapture. The following table summarizes the relationship between the developer and outside investors. NOTE: This is only meant to demonstrate the concept of partnerships for such projects and is not to be taken as literal guidelines for developing a LIHTC project.
States are also responsible for monitoring the ongoing development costs, quality and operation of approved projects, as well as the enforcement threat of notifying the IRS of "noncompliance" if the project deviates from the applicable requirements of the Code and the LURA, described above. Such a notice can lead to recapture of previously taken credits and inability to claim credits from the project in the future. The IRS has published Form 8823 for the purpose of reporting possible problems with the project, and its Guide to the Form 8823 that details the IRS view on various issues related to noncompliance.
Owners of LIHTC properties and their management agents must be able to prove the tenants living in the low income units meet the eligibility requirements of the LIHTC Program and remain eligible throughout their tenancy. [Section 1.42-5(b)] The initial eligibility requirements include, but are not limited to, income eligibility, rent restriction, full-time student limitations, and non-exclusion of Section 8 applicants. Also, each year the tenant remains in the low-income unit, a re-examination or recertification must be performed to ensure the tenant continues to remain LIHTC Program eligible. Failure to correctly prove initial eligibility and re-examine continued eligibility is noncompliance and puts the LIHTC owner at risk of losing its credit claim.
Thorough documentation of tenants' eligibility is required and records must be maintained for each qualified tenant. Records from the first year of participation in the LIHTC Program must be maintained for 21 years from the date the tax return claiming these credits was filed including all extensions and subsequent years records must be maintained for 6 years from the date the tax return claiming the applicable credits was filed including all extensions. [Section 1.42-5(b)(vii)(2)]
Owners must report on the compliance status of the LIHTC property at least annually to the State Allocation Agency in which it received its credit allocation. [Section 1.42-5(c)] At least annually, State Allocation Agencies are required to monitor and inspect the LIHTC properties in which it has allocated credits. Any discovered or suspected noncompliance must be reported to the Internal Revenue Service (IRS) using IRS Form 8823. State Allocation Agencies must follow very specific requirements for monitoring, inspecting and reporting as laid out by the IRS. [Section 1.42-5 and Federal Register: January 14, 2000 (Volume 65, Number 10) - Compliance Monitoring and Miscellaneous Issues Relating to the Low-Income Housing Credit] 
Owners and their management agents are strongly encouraged and in some cases mandated by their State Allocation Agencies to become certified compliance professionals. Certifications can be obtained by several LIHTC industry groups. The Education Requirement is met by successfully passing an industry exam and accruing the applicable number of required course hours. The Experience Requirements vary among designations. All designations also contain a continuing education component to ensure certified professionals maintain their knowledge and keep abreast of the LIHTC Program changes.
Introduction to compliance
In order to know how to comply, one must first understand the meaning of compliance. Let us look at the definition of compliance. Compliance is the act of yielding to a wish, request, or demand; acquiescence. In other words, to do as you are directed, to follow the rules or demands of another.
The Low Income Housing Tax Credit Program (LIHTC) was created under the Tax Reform Act of 1986. The Program provides federal tax credits to owners and investors of qualified low- income housing properties that have been acquired constructed or rehabilitated since 1986. In exchange for these tax credits, the owners, investors and developers agree to adhere to the LIHTC Program's policies and regulations that entail strict eligibility guidelines. The compliance period lasts a minimum of 15 years, but may be extended by agreement. Some properties may be restricted indefinitely.
How does Compliance pertain to you?
Some of the communities that your company manages participate in a federal income tax credit and other programs instituted by Congress, to provide eligible households quality and affordable home living. To insure the integrity of the programs, the IRS and HUD have state and local agencies oversee compliance with their regulations.
How does this affect your community?
Whenever you have a valuable item such as tax credits and other affordable housing programs the demand is usually greater than the supply. Whoever meets and maintains compliance (adheres to the requirements of the IRS, HUD and the state) may utilize the assistance; whoever does not comply, (ignores these requirements) will be found to be in NON-COMPLIANCE and could be eliminated from using the programs. Our business is based on managing communities that have secured these tax credits. If we do not adhere to the rules, and are found to be in NON-COMPLIANCE, the community could lose the assistance, and subsequently we could lose the management. The bright side is, if you follow the guidelines,compliance is easy! This introduction outlines the compliance issues relevant to the Low Income Housing Tax Credit Program (LIHTC), Bonds, and HOME as set forth in Section 42 of the Internal Revenue Code, HUD Handbook 4350.3 and state Compliance Guidebook. State agencies administer the Programs and conduct routine audits of the resident files by visiting the communities on a regular basis. This is to insure that the community and owners adhere to the program rules. They also require submission of reports on a regular basis, documenting the demographics and income of our residents. All of the units at your community are regulated by the Internal Revenue Service and monitored by your particular state agency.
Managing a Tax Credit Property
Note: Remember, if you have more than one program on your property, you should always use the most restrictive guideline.
To successfully manage a tax credit property, you must always have the following information at hand. This can be found in the Land Use Restriction Agreement (LURA) for your property:
- The number of units set aside for tax credit compliance requirements.
- The applicable maximum incomes for each family size.
- The maximum allowable gross rents.
- The utility allowance for each unit size.
- Resident services promised on the Land Use Restriction Agreement (LURA) and/or Extended Use Agreement (EUA).
The following information needs to be posted where all residents and prospective residents can see it:
- Income Limits and Rents.
- Utility Allowance Chart.
- Resident Selection Policy.
- Late Charge Policy.
- Fair Housing Poster (English and Spanish).
- Office Hours.
- Emergency Phone Numbers.
Basic Requirements for a unit to be counted as a Tax Credit unit, the following seven conditions must be met:
- All units in the same building identification number must be certified by qualified households.
- The resident's income may not exceed the applicable income limit for your community (at time of move- in).
- The rent paid by the resident plus allowance for resident-paid utilities may not exceed the maximum allowable rent for that unit.
- The physical condition of that unit must meet local health, safety and building codes.
- Owner/manager must execute a lease of six months or more with the household.
- Owner/manager must list the unit as an eligible unit on reports submitted to the state or local agencies.
- Owner/manager must re-examine the resident's eligibility annually and maintain rents at or below applicable rent limits.
There are four key stages in the life of a Tax Credit project:
- Development Period The development period for a project begins when commitment of LIHTCs, or other Affordable Housing program(s) is made by the state and lasts until the owner places the project in service. A building is determined to be "placed in service" when the first unit is ready for occupancy (certified for occupancy). In general, the owner must place the project in service before the end of the 2nd calendar year in which the project receives its LIHTC or other Affordable Housing program commitment.
- Lease-Up Period The lease-up period starts once a project has been placed in service and lasts until the owner begins to claim the project's Tax Credits. Owners can start claiming a project's Tax Credits at the end of the following tax year the project was placed in service. During this period, owner/managers need to qualify all of the units they will count as set-aside.
- Compliance Period The compliance period begins with the first tax year in which the owner claims Tax Credits for the project, and lasts for 15 consecutive years.
- Extended Use Period Once the 15-year compliance period ends, projects enter the extended use period. Owners/managers of these projects are required to maintain the property's low-income occupancy for an additional 15 years beyond the end of the compliance period - the remaining life of the extended use agreement for the project (in some cases longer, for example most of our communities require a 50 year extended use period).
After a state inspection, non-compliance findings are reported on IRS Form 8823. This form is completed by the state and sent to the IRS. There could be financial consequences to the owner that would amount to thousands and thousands of dollars should they be found in non-compliance. Property management companies must do all they can to not get 8823s and when they do, correct these immediately.
Not correctable Non-Compliance
- Overcharging tenant rent.
- Ineligible household.
- Improper transfers.
- Ineligible students.
- Not reporting in a timely manner.
- Not calculating assets correctly.
- Not calculating income correctly.
- Health and life safety issues such as smoke detectors.
- Not updating Utility Allowance figures annually as required.
- Using incorrect Income Limits - not updating yearly in a timely manner.
- Not having the resident file information such as application, certification and/or lease.
- Not complying with the time. requirements of forms required by the monitoring agency.
- Exceeding Maximum Allowable Rent as a result of using incorrect AGMI or Utility Allowances.
- Not completing required annual income certifications in a timely manner on properties that are not 100% LIHTC.
- Failure to make the next unit available to a Housing Credit qualified household when an existing HC household's income exceeds 140% of the maximum allowable income.