Documents Critical to the IRS Section 42 Audit Process
person
A.J. Johnson
today
01/20/2019
DDespite a recent increase in IRS audit activity relating to Low-Income Housing Tax Credit (LIHTC) projects, audits of such projects remain relatively rare. However, such audits do occur, and owners should ensure that record retention protocols include the documents that are likely to be part of any IRS audit.
If the
IRS selects a LIHTC property or owner for audit, the initial step will usually
be a notice by mail to the property owner. This notice will request documents
to be made available for the audit. This request is known as an Information
Document Request (IDR) and is issued on IRS Form 4564.
The
IRS has broad authority when requesting documents. IRC §7601 empowers IRS
employees to "inquire after and concerning all persons who may be liable for
any internal revenue tax." IRC §7602 authorizes the IRS to examine any books,
materials, data, or papers that may be relevant.
Owners
should be aware of and familiar with the forms that the IRS will review as part
of a Section 42 audit.
Owner-Submitted IRS Forms
In
addition to the forms submitted annually when claiming the credits, owners are
required to submit a one-time "First-Year Certification" on IRS Form 8609. This
form identifies specific information needed for program administration and
documents specific elections that will govern how the site is operated.
Form 8609
Part I
of the 8609 is completed by the allocating agency. It documents approval of the
building (every building receives a separate 8609) and shows the maximum annual
credit that may be claimed on the building.
Part
II of the form is completed by the owner and specifies a number of elements
critical to operating the building. Owners are not entitled to credits until
Part II has been completed and sent to the IRS. Housing Finance Agencies (HFAs)
are often slow in issuing 8609s and owners may be tempted to claim credit prior
to receipt of the 8609. The IRS takes his very seriously and may believe that
an owner is fraudulently claiming the credit. If an owner cannot provide a
reasonable explanation for an early claiming of credits, the IRS may disallow
and/or recapture credits.
The
Form 8609 is only submitted for the first year of the credit period.
Form 8609-A
This
form is sent to the IRS for each year of the 15-year compliance period. The
form is submitted for each building and is a complement to the 8609. It is this
form that shows the amount of credit for a building each year.
Form 8586
This form
summarizes key information from the Forms 8609-A and is filed with the IRS for
each year that credits are claimed. This form shows the amount of credit
claimed for the entire project during that year (the 8609-A forms show credit
for each building).
Form 8823
This
form is submitted by the HFA to the IRS whenever an HFA discovers noncompliance
or an owner disposes of a property through sale, foreclosure, or destruction.
An uncorrected 8823 is a major trigger to potential IRS audit activity.
General Recordkeeping & Retention Requirements
26 CFR
Part I - 1.42-5(b) specifies owner recordkeeping and retention requirements for
the Section 42 program. In addition to the retention of site records, owners
must also provide annual reports to the HFA. At a minimum, the following
records are required:
Records for each qualified low-income
resident by building and unit for the entire 15-year compliance period;
Copies of tenant files;
Records regarding the use of facilities
included in the project’s eligible basis;
Records for the first year of the
credit period must be retained for at least six years after the due date of the
tax return for the last year of the compliance period. These are known as "21-year files."
All other records should be retained
for at least six years after the due date for filing of the tax return for that
year.
Initial Information Document Request (IDR)
The
first document request is likely to ask for the following:
General Information
Partnership Agreement;
Prospectus/Offering Memorandum related
to the organization or syndication of the partnership;
Documentation of the partners’ capital
contributions and current balance;
Credit Allocation Application;
Market Study;
Credit Allocation Award or Carryover
Allocation;
Extended Use Agreement;
All Forms 8609 issued to the owner; and
Internal Audit reports.
Tax Returns
Copies of tax returns for the tax year
prior to the earliest year under audit, and all tax returns for years after the
tax years under audit;
Trial balance and any work papers used
to prepare the tax return under audit; and
Depreciation schedules.
Eligible Basis
Final cost certification submitted to
the HFA with supporting documentation;
Documentation of all financing sources;
Development contracts or agreements;
and
Documentation of cost allocations
between land, nonqualifying land improvements, and depreciable residential
rental property included in eligible basis.
Low-Income Households
For the years under audit, rent rolls
identifying the households and family size for each low-income unit; and
Documentation of internal controls in
place to ensure that income-qualified households occupy the low-income units.
First and 11th Year of the
Compliance Period
If the first year of the compliance period
is audited, the specific rule for computing the applicable fraction under
§42(f)(2) is used. The owner will be requested to provide:
Certificates of occupancy;
A schedule showing when each low-income
unit was first occupied by an income-qualified household; and
Computation of the first-year
applicable fraction, including the computation of the applicable fraction on a
monthly basis.
If the 11th year of the
compliance period is audited and the owner has claimed credit in that year, the
owner will be asked for the information noted above as well as a copy of tax
documents for the first year of the credit period.
Additions to Qualified Basis
A list of units first occupied by
qualifying tenants after the end of the first year of the compliance period,
identifying when a qualifying household first occupied the unit; or
Confirmation that all units were
occupied by qualified households by the end of the first year of the credit
period.
Rents & Other Sources of Income or
Funds
Description of residential rental units
including total number of units, total number of low-income units, size
(bedrooms), and rents charged for low-income and market units;
Documentation that rents are properly
restricted;
Sources of rent subsidies;
Documentation for the computation of
any utility allowances;
Fees for services provided to tenants
in addition to housing;
Other income from related activities
such as vending machines, laundry facilities, etc.;
Other income from sources such as
commercial use of a portion of the property; and
Documentation of funds received from
other sources such as federal grants or subsidies received during the year, additional
capital contributions, or loan proceeds.
Noncompliance
If the audit was triggered by receipt
of 8823s, the owner will be asked to document corrective actions taken.
Dispositions
If the site was sold, the IRS will
request documentation regarding the sale. These documents will include:
Sales contract;
Settlement documents;
Computation of capital gain/loss;
How the gain/loss was distributed among
the partners; and
Whether the sale required the new owner
to operate the site as a qualified low-income project for the remainder of the
15-year compliance period.
Every
owner of a LIHTC project should have a system in place for retaining records
required by the Internal Revenue Code. The items noted above will form the core
of the documents to be retained and protected.