News

The Importance of Internal Controls

All executives are taught the importance of "internal controls." Unfortunately, many executives don t fully understand what is meant by the term "internal controls." A recent HUD audit of a Section 8 project in Port Arthur, TX serves as a reminder of the importance of both understand what is meant by the term internal controls, and the importance of having such systems in place.   What are Internal Controls   Internal controls are methods put in place by a company to ensure the integrity of financial and accounting information, meet operational and profitability targets, and transmit management policies throughout the organization. Internal controls work best when they are applied to multiple divisions and deal with the interactions between the various business departments. No two systems of internal controls are identical, but many core philosophies regarding financial integrity and accounting practices have become standard management practices.   The importance of understanding these principles were made evident by the findings of the HUD investigation.   Details of the Audit   The HUD Office of Inspector General (OIG) audited the multifamily Section 8 project in Port Arthur (Villa Main Apartments) to determine whether the project owner was administering the Section 8 program in accordance with HUD regulations and guidance.   HUD found that the owner did not administer the Section 8 program at Villa Main in accordance with HUD regulations and guidance. It assisted at least 82 tenants who were either ineligible for assistance because they did not exist or the tenant eligibility and the unit physical condition standards could not be supported. These conditions occurred because the owner and the former management agent lacked oversight of the staff. They also failed to establish effective control systems, which allowed the onsite employees to commit fraud. The employees falsified tenant eligibility, did not properly verify tenant income, and did not inspect the units are required by HUD. As a result, HUD paid the owner $534,741 in subsidies for ineligible "ghost" tenants and incurred more than $1 million in subsidies for which the owner could not support the tenants subsidy amounts or that the units were in decent, safe, and sanitary condition.   The Result   As a result of the findings, the OIG recommended in January 2018, that the project owner be required to (1) repay HUD $534,741 for housing subsidies received for ineligible nonexistent "ghost" tenants, and (2) support or repay HUD more than $1 million for tenants whose eligibility the owner could not support. In addition, HUD should require the Contract Administrator to ensure that the owner s recently implemented quality control program is working as designed and in accordance with HUD regulations. OIG also recommended that appropriate administrative actions be taken against the owner.   The results of this audit reinforce the importance of good internal controls, and the critical importance of redundant systems and strong oversight. Every owner and management company should have a system in place that includes internal audits, capital control, quality control, administrative accounting, and third party reviews. Failure to have such systems in place can result in situations similar to the one I ve outlined here. Take the time to examine your current systems, identify weaknesses, and implement improvements.

Possible Work Requirements and Rent Changes for Affordable Housing

I have recently reviewed a draft, unpublished document dated January 17, 2018, from HUD that introduces minimum work requirements for some residents of assisted housing and raises rent for others.   This seems to continue the pattern of requiring work in return for some forms of welfare assistance. In January, the Administration said that it would permit states to impose work requirements for Medicaid and the Department of Agriculture announced in December that it will permit states to set work requirements for people who use the SNAP (food stamp) program.   While requiring work in return for aid seems reasonable, a review of the specific proposals raises questions about the impact on the most at risk families.   The proposed changes would allow public housing agencies (PHAs) to introduce minimum employment requirements for families in order to be eligible for housing assistance. Without proof of employment, housing assistance could be denied. This is only a draft (discussion) document, but it has a lot of weaknesses relative to the broad swath of families that would be impacted. For example, the draft does not provide exceptions for persons who need to care for children or disabled relatives. Nor, does it address the circumstances when a person just cannot find a job. It also does not deal with the issues of seasonal or cyclical employment.   While requiring able-bodied adults to work, train, or volunteer - at least on a part-time basis - in return for taxpayer assistance is reasonable, this draft document does not recognize volunteer work toward the minimum work requirements, nor does it count part-time work. This is a major weakness, since obtaining part-time work may be very possible, but full time employment opportunities are much more limited.   Incredibly, the language in the document includes no exemption for parents who care for children, essentially giving PHAs discretion as to whether single mothers could qualify for the housing. If such loss of housing were to occur due to a lack of employment, the risk to families would increase significantly. Without adequate housing, children may very well be placed in foster care.   The draft language caps the work requirement at 32 hours per week on average per adult, excluding elderly or disabled families. Both active employment and vocational training would qualify.   In addition to the work requirement, the proposal would raise the rent-burden on low-income families from 30% of adjusted income to 35% of gross income. Under this proposal, there would be no more deductions for expenses such as medical, dependent, childcare, disability, etc. Under the draft guidelines, each household would be required to pay a minimum rent of $50 - including elderly and disabled - regardless of income.   This draft document may explain why there has not yet been a regulatory implementation of the 2016 Housing Opportunity Through Modernization Act (HOTMA). It appears that the current administration may want to go in a completely different direction. Since HOTMA is statutory, HUD cannot just ignore its requirements. However, regulatory agencies have great discretion in how they interpret laws and HUD appears to be looking for ways around some of the HOTMA requirements.   If I receive any more information about informal HUD efforts in these areas I will let you know, but at this point, I would not count on any short-term regulations from HUD implementing the changes outlined in the 2016 legislation.  

Rental Assistance - Is It Income or Not?

After more than 40 years in the affordable housing business, I still occasionally get the question as to why federal rental assistance - such as Section 8 - is not counted as income. After all, it is a regular, recurring payment made on behalf of a household, and it does not appear to be excluded income under HUD regulation. I advise my students and clients on a regular basis that unless income is specifically excluded by HUD regulation (as outlined in Exhibit 5-1 of HUD Handbook 4350.3), it should be counted as income for purposes of all federally assisted housing programs (and most state and local affordable housing programs as well).   It is true that rental assistance is not shown as a specific excluded income in HUD regulations. This is because the language in the Included Income section of Exhibit 5-1 and in the underlying statute (The Housing Act of 1937) eliminates the need to specifically exclude rental assistance.   The Housing Act of 1937 requires that persons renting housing in programs covered by the Act pay the greater of 30% of adjusted income or 10% of gross income in rent. Based on this requirement, federal rental assistance cannot be counted as income because if it was counted as income, the result would be a circular calculation and neither the income nor the rent could be determined. A quick example illustrates the problem.   Assume a household with gross income of $20,000 and adjusted income of $19,040. Ten percent of gross income on a monthly basis is $167 and 30% of adjusted income on a monthly basis is $476, so the household s monthly rent will be $476. On an annual basis, this is $5,712. If added to the gross income, the gross income would be 25,712 and the adjusted income would be $24,752 - the required rent would be $619. Of course, this would have to be added to income, making the new income $32,178, the new adjusted income $31,218 and so on - ad infinitum.   In short, if rental assistance, that is adjusted based on income, is counted as income, neither the rent nor the income could ever be determined. While hard to discern, this is actually addressed in the Included Income Section of HUD Handbook 4350.3, Exhibit 5-1. Number 7 of the Included Income section states that "Periodic and determinable allowances" should be counted as income. As shown above, if counted as income, the amount of rental assistance is not "determinable," and therefore is not considered income.   This same requirement should be applied to state or local rental assistance that is paid (and adjusted) based on the income of the family receiving assistance. However, if any rental assistance is determinable (i.e., does not change regardless of the income of the household), it should be considered income and added to the gross income of the household.    

Civil Rights Lawsuit Brought Against America's Largest Landlord for Criminal Screening Procedures

In a complaint filed in the United States District Court for the District of Columbia on December 12, 2017, the nonprofit Equal Rights Center (a Washington, DC civil rights group), and the Washington Lawyers Committee alleged that Mid-America Apartments policy of forbidding anyone with a "felony conviction or pending felony charge as well as certain misdemeanors or pending misdemeanor charges" from renting an apartment. The complaint alleges that the practice violates the Fair Housing Act of 1968 because it has a "disproportionate adverse impact on African Americans and Latinos."   Mid-America is the largest corporate landlord in the United States, with more than 100,000 apartments under management across the Southwest and Southeast United States.   The complaint alleges that Mid-America enforces the policy in at least 55 apartment communities with over 20,000 units. The complaint asks the court to stop the company from enforcing the policy and demands damages "that would punish Defendants for the willful, malicious, and reckless conduct alleged herein and that would effectively deter similar conduct in the future."   Based on the complaint, the company s practice goes against instructions issued by the U.S. Department of Housing and Urban Development (HUD), which require that any restrictions placed on applicants based on criminal history "must be tailored to serve the housing provider s substantial, legitimate, nondiscriminatory interest and take into consideration such factors as the type of the crime and the length of the time since conviction." The investigation that led to the complaint revealed that applicants who disclosed a felony conviction through the company s online application portal were not even able to submit an application for review because a felony conviction worked as an absolute bar to applying for an apartment.   I sent a memo to clients on April 6, 2016, outlining the basic elements of the HUD policy, which essentially states that only prior convictions for crimes relating to living is a housing environment, such as drug crimes, violent crimes, property crimes, and sex offenses should be considered when making housing decisions. Also, issues such as the length of time since the conviction, the severity of the crime, and activities since the crime should all be considered in the housing decision.   This is the first major action filed against a large landlord based on criminal screening policies. It should serve as a reminder to all owners and management companies to carefully review any criminal screening policies for compliance with HUD guidance.    

Independent Contractor or Employee - How to Tell the Difference

Affordable housing property managers are required to verify the income of applicants and residents in order to determine both eligibility and (for some programs) rent. The most common type of income requiring verification is employment income and the most common verification method for employment income is third party verification from the employer. This verification is most commonly a written verification from the employer or pay stubs.   Verification is also required when an applicant is self-employed or an "independent contractor." In these cases, we tend to rely on financial records provided by the applicant, such as tax returns or financial statements. Compliance professionals and affordable housing property managers must be able to distinguish between an employee and an independent contractor, which is not always easy, since the line between the two is often blurred. This article is intended to provide guidance that may assist affordable housing professionals in determining whether an individual is an employee or an independent contractor.   For many years, employers have recognized a number of benefits of using independent contractors instead of employees for some types of jobs. As with most things, however, those benefits carry some risk. Most of that risk arises because of the difficulty in determining independent contractor status. Whether an individual rendering services to a company is an employee or an independent contractor is often unclear. Even if the parties themselves characterize their relationship as an independent contractor arrangement, courts and governmental agencies will look beyond that classification to determine the "real" relationship. Following is a discussion of the three primary aspects of the employer/worker relationship that must be examined in determining how to classify the arrangement. These three elements are (1) behavioral control, (2) financial control, and (3) type of relationship.   Behavioral Control - facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of -   Instructions the business gives the worker. An employee is generally subject to the business instructions about when, where, and how to work. All of the following are examples of types of instructions about how to work: When and where to do the work; What tools or equipment to use; What workers to hire or to assist with the work; Where to purchase supplies and services; What work must be performed by a specified individual; and What order or sequences to follow. The amount of instructions needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work is done. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker s performance or, instead, has given up that right.   Training the business gives the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.   Financial Control - Facts that show whether the business has a right to control the business aspects of the workers job include: The extent to which the worker has unreimbursed business expenses. Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with the services they perform for their business; The extent of the worker s investment. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not required for independent contractor status; The extent to which the worker makes services available to the relevant market. An independent contractor is generally free to seek out business opportunities. Independent contractors may advertise, maintain a visible business location, and are available to work in the relevant market; How the business pays the worker. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when a commission supplements the wage or salary. An independent contractor is normally paid by a flat fee for the job, or in the case of professionals, by an hourly rate; and The extent to which the worker can realize a profit or loss. An independent contractor can make a profit or loss.   Type of Relationship - facts that show the parties type of relationship include the following:   Written contracts describing the relationship the parties intended to create; Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay; The permanency of the relationship. If a worker is engaged with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer-employee relationship; and The extent to which services performed by the worker are a key aspect of the regular business of the company. If a worker provides services that are a key aspect of the regular business activity, it is more likely that the employer has the right to direct and control those activities. For example, if a management company hires a compliance professional, it is likely that the company will present the work of the compliance professional as its own and would have the right to control and direct that work. This is indicative of an employer-employee relationship.   While in most cases, the type of relationship is clear, there are times when management professionals have to determine whether an applicant is an employee or an independent contractor, and verify income accordingly. Understanding the concepts outlined in this article may assist in making that determination.      

Self-Employed Individuals in Affordable Housing Properties

One of the most difficult type of income to determine for managers of affordable housing rental properties (e.g. Section 8 or Low-Income Housing Tax Credit [LIHTC]) is self-employment income. Based on the number of issues we see when reviewing the tenant files of clients and the questions I receive on the subject during training, a discussion of best practices with regard to verifying and projecting income from self-employment is in order.   All affordable housing programs require that income from businesses be counted as part of household income, and virtually all such programs follow guidance of the Department of Housing & Urban Development (HUD) in how to deal with self-employment income. This includes the LIHTC program, for which the IRS has provided additional guidance relative to self-employed individuals.   Income from a Business   The net income from the operation of a business, profession, or sole proprietorship businesses is included in income. Net income is gross income less business expenses, interest on loans, and depreciation computed on a straight-line basis. Salaries paid to the applicant or other household members from the business must also be identified and included in income. In addition, cash and assets withdrawn by family members must be included in income except when the withdrawal is a reimbursement of cash or assets invested in the business.   Business expenses do not include principal payments on loans, interest on loans for business expansion or capital improvements, or other expenses for business expansion or outlays for capital improvements.   If the net income from a business is negative, it must be counted as zero income. A negative amount cannot be used to offset other family income.   Example: Negative Income from a Sole Proprietorship John and Mary, a married couple, apply for LIHTC housing. John operates a sole proprietorship business. The net income from the business after expenses in 2017 was -$3,500. Mary earns $27,000 annually as an employee, as verified by management with her employer. The household s income is $27,000; the $3,500 loss by John s business cannot be used to offset Mary s wages.   Income from a business can be estimated by reviewing the individual s prior year tax returns and Schedule C. If necessary, the owner can ask the potential resident to provide a signed Form 8821, Tax Information Authorization, or Form 4506-T, Request for Transcript of Tax Returns, which will allow the owner to verify the information with the IRS. Another option is to request that a copy of the transcripts be sent directly to the potential resident from the IRS by using the automated phone system (1-800-908-9946). While the transcript will be sent to the applicant and they will have to bring it to the manager, this process is faster and the applicant will normally receive the transcript(s) within ten days. It should be noted that a tax return must be filed for all self-employed individuals who operate sole proprietorship businesses or otherwise report income on Schedule C, regardless of whether the taxpayer is reporting a profit or loss. If a person is not eligible to get a Social Security Number, which is needed to file a tax return, an individual taxpayer identification number (ITIN) can be obtained using IRS Form W-7.   Income Projection Methods   There are a number of acceptable methods for projecting income from self-employment; three examples follow:   Example 1: A potential LIHTC tenant has been self-employed for four years and provides a self-employment affidavit (which is always recommended) stating that the anticipated net income for the upcoming year is $22,000. Tax return for 2014, 2015, and 2016 are obtained and show the following net income: 2014: $13,000 2015: $18,000 2016: $20,000 Based on the trend as shown on the tax returns, the estimated amount on the self-employment affidavit appears reasonable and may be used. However, if the 2016 return showed net income of $26,000, the applicant should be required to provide a credible reason for the anticipated reduction in income, and if they could not, the income should either be trended based on the percentage increase from year-to-year or the 2016 income should be used - depending on the circumstances.   Example 2: A potential LIHTC tenant has been self-employed for just over one year and provides a self-employment affidavit stating that the anticipated net income for the upcoming year is $22,000. The 2016 tax return is obtained and shows that $22,000 was the net income in 2016. It is reasonable to project $22,000 as the income from the business.   Example 3: The potential tenant has only been self-employed for nine months and no tax return has yet been filed. Income may be annualized based on the number of full months in business. The formula is:   (Net Income Year to Date) x 12 Months _________________________________________________________ Number of Months in Business during the Current Year   So, if for the nine months of the year in business the applicant had earned net income of $24,000, the formula is:   $24,000 X 12 = $288,000 9 months + $32,000 anticipated net income.   Home Businesses   A low-income tenant may use a portion of a low-income unit exclusively and on a regular basis as a principle place of business, and claim the associated expenses as tax deductions, as long as the unit is the tenant s primary residence. If the tenant is providing daycare services, the tenant must have applied for (and not have been rejected), be granted (and still have in effect), or be exempt from having a license, certification, registration, or approval as a daycare facility or home under state law. IRS Form 8829, Expenses for Business Use of Your Home, and Publication 587, Business Use of Your Home, provide additional guidance on acceptable deduction from business income for home businesses.   Example: A self-employed bookkeeper wants to rent a two bedroom unit and intends to use one bedroom as her principle place of business; i.e., to provide bookkeeping services. She provides her tax return for the last year, which includes a Schedule C, as a verification of her income. The Schedule C includes an "office expense" for her home office in a prior residence. Use of a unit in this way meets the requirements of the LIHTC program, but it should be noted that Section 8 residents would not be able to use the second bedroom as a dedicated office.   Income from Rental Property, Partnerships, and S-Corporations   Rental property may be real estate or personal property such as equipment or vehicles. The tenant may have income from enterprises doing business as partnerships or S-Corporations, or receive royalties for copyrights or patents.   The key, when determining income for self-employed individuals, is to obtain enough information to reasonably project likely income for a 12-month period. As noted, tax returns are the preferred method of verifying such income, but financial statements (audited or unaudited) are acceptable when tax returns are not available. Also, it is strongly recommended that self-employed individuals always provide "Affidavits of Self-Employment" on which they state their anticipated income for the upcoming year.

NCSHA Publishes 2017 Recommended Best Practices

The National Council of State Housing Agencies (NCSHA) has updated its Recommended Practices in Housing Credit Administration for voluntary adoption by Housing Credit Agencies. The organizations first recommended practices were published in 1993, and included recommendations relative to allocation and underwriting. These recommended practices were updated in 1998. In 2000, NCSHA published its first recommended practices relative to Housing Credit compliance monitoring, and in that same year, provided further updates to recommendations relating to allocation and underwriting, with additional recommendations provided in 2009 and 2010. This new series or recommendations includes significant revisions to many recommended practices in allocation, underwriting, and compliance monitoring. There are also 13 new Recommended Practices. This new report was approved by the NCSHA Board of Directors in December 2017. It is important to remember that these recommendations are voluntary, and no Housing Credit Agency (HCA) is obligated to adopt them. The report outlines recommendations in 46 separate areas; highlights of some of the major changes in recommended policies are noted in this memo. Development Costs: the report recommends that "In addition to carefully calculating the amount of housing credit allocated to eligible developments, as federal law requires, each allocating agency should develop a standard for limiting development costs to reasonable amounts. This standard may take the form of a development cost limit, calculated on a per unit, per bedroom, or square footage basis." The report also urges each allocating agency to have a general developer fee limit (which virtually all have already done). Agencies are also being urged to define what an acceptable consulting fee is and to review those fees - including at minimum fees for architectural, engineering, environmental, accounting, legal, market analysis, construction management, and asset management services - at project application and compare them with professional fees charged in developments awarded credits in prior funding cycles and with current applications. Preservation: The report recommends that HCAs should develop QAP policies on the use of 9% and 4% credits for preservation, including specific policies on resyndication of existing LIHTC projects. Qualified Contracts: In one of the more controversial areas of the report, NCSHA recommends that agencies "require all applicants to waive their right to submit a qualified contract as a condition of receiving an allocation. The waiver requirement should apply to applicants for both 9% and 4% credits financed with tax-exempt multifamily bonds." Many HCAs already require applicants to waive the right to seek a qualified contract at the time a credit allocation is made, while others provide scoring incentives for applicants that agree to waive the right to a qualified contract. This recommendation is particularly interesting in that it recommends requiring that developers be required to waive a right provided by federal law in order to participate in a federal program. To date, I know of no one who has challenged the legality of such a provision, but it would make for an intriguing case. Reducing Local Barriers to Development: NCSHA also seeks to address concerns about local requirements and support for LIHTC proposals. While inviting local jurisdiction comment on proposed LIHTC developments is required by statute, agencies should not require local approval (for example, a letter of support) as a threshold qualification or allocate points for local approval as part of a competitive scoring system. Moreover, agencies should not require local financial contributions as a condition for receiving a housing credit allocation, says the report. This practice came under harsh criticism in a recent GAO report on State Agency implementation of the program. Construction Monitoring: Construction monitoring is a new recommended practice. In addition to visiting proposed development sites prior to allocation of credits, HFAs should inspect or require an independent third-party inspection of credit developments during the construction period to monitor construction progress, verify application commitments, evaluate compliance with fair housing and accessibility rules, and identify construction delays, says the report. To avoid duplication of efforts, agencies may coordinate with investors, syndicators, lenders, or other entities to receive copies of construction monitoring reports conducted by these entities. Agencies have found that site visits to developments during the construction phase help monitor construction progress and identify potential timing delays. These visits also help make sure that developments adhere to commitments made at the time of application and with fair housing and accessibility rules. Violence Against Women Act (VAWA) Compliance: The report recommends that agencies adopt specific policies and procedures relative to implementation of VAWA. The recommendation essentially follows the procedures outlined by HUD for implementation of VAWA at HUD properties. Owner & Manager Training: The report recommends that agencies require that owners and on-site managers of LIHTC projects receive LIHTC specific training no later than issuance of an 8609. The report states that "Agencies should consider requiring certification or professional designation of Housing Credit property managers." As noted, recommendations are made in 49 separate areas, but most have not changed from prior recommendations. Interestingly, there are no major recommended changes regarding compliance monitoring, and the report generally indicates that agencies should defer to HUD rules in terms of monitoring for resident income eligibility. Most importantly, owners and managers should keep in mind that these recommendations are just that - recommendations. There is no requirement for any HCA to implement any of the recommendations.        

HUD Delays Fair Housing Affirmative Action Rule

In what is almost certainly the first step in elimination of the requirement that localities take proactive steps to affirmatively further fair housing, HUD is extending the deadline for submission of assessment of fair housing for Consolidated Plan Participants. This extension was published in the Federal Register on January 5, 2018. It extends the deadline for submission of an Assessment of Fair Housing (AFH) by local government consolidated plan program participants to their next AFH submission date that falls after October 31, 2020. According to the Notice, while program participants will not be required to submit an AFH, they are still required to continue to comply with existing obligations to affirmatively further fair housing. Local governments that have already submitted an AFH that has been accepted by HUD must continue to execute the goals of that AFH. The original concept of the Obama era policy was to provide an enforcement mechanism to a federal Civil Rights law requirement that local governments take affirmative steps to undo racial segregation. HUD is now saying that the extension is simply to give communities more time to deal with the complex requirements of the ruling. However, the more likely explanation is that this delay is designed to ultimately kill the regulation and implement the desire of Ben Carson, the HUD Secretary, to do away with "social engineering," as he called this program before he was appointed HUD Secretary. Based on this Notice, it is likely that communities that were in the process of complying with the AFH requirements of the prior regulation will simply cease their activities in this area, returning to the status quo of giving localities virtually unfettered ability to decide if and when to pursue desegregation policies. This obviously impacts the provision of affordable housing, since many localities restrict the development of affordable housing to areas that are already impacted by poverty and limited opportunity.