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LIHTC Requirements Regarding Common Areas, Required Facilities, and Provision of Services

Section 42(d)(4)(B) of the Internal Revenue Code reads: "The adjusted basis of any building shall be determined by taking into account the adjusted basis of property (of a character subject to the allowance for depreciation) used in common areas or provided as comparable amenities to all residential rental units in such building." This is basically the statutory provision that allows owners of Low-Income Housing Tax Credit (LIHTC) projects to include in eligible basis the cost of common areas, as long as certain requirements are met.   Common Area   Common areas are facilities expected to be used by the tenants and can be reasonably associated with residential rental property. Examples provided in IRS guidance include parking areas and swimming pools. To qualify, the facility must meet two requirements:   The common area must be made available on a comparable basis to the tenants of all residential rental units (not only low-income tenants); and   No separate fee is required for the use of the facilities. This was made clear in the legislative history when 42 was originally passed as part of the Tax Reform Act of 1986, which stated, " the allocable cost of tenant facilities, such as swimming pools, other recreational facilities and parking areas, may be included provided there is no separate fee for the use of these facilities and they are made available on a comparable basis to all tenants in the project."   If such common area is excluded from eligible basis, IRC 42 does not control the taxpayer s use of the common area.   Reasonably Required Facilities   A facility reasonably required by the project is, under Treasury Regulation 1.103-8(b)(4)(iii), residential rental property that is functionally related and subordinate to the residential rental units.   Examples of such facilities include employee units, which are not considered residential rental units, but rather as facilities reasonably required by a project that are functionally related and subordinate to the rental units. Therefore, such employee units may be included in eligible basis for cost purposes, but are not part of the applicable fraction of the building.   Revenue Ruling 2004-82, Q&A #1 explains that units occupied by security officers are also treated as reasonably required facilities.     Facilities Used to Provide Services   Eligible basis also includes facilities used by the owner of the project to provide tenants with services not normally associated with the leasing of residential rental property. For example, projects that provide common dining areas in which regularly prepared meals are served, may include the cost of the dining and kitchen facilities in eligible basis. Any fees charged to residents for meals or other services must be optional to the tenants; otherwise, the fees must be included for purposes of the gross rent calculation.   In summary, to be included in eligible basis, common areas must be (1) a facility reasonably required by the project; (2) subordinate to the residential rental units; (3) available to all residents on a comparable basis; and (4) available for no fee. LIHTC operators should be reminded that the "no fee" requirement is absolute. In other words, an outside entity also could not be charged a fee to use common area that was included in eligible basis.

Quid Pro Quo and Hostile Environment HUD Proposed Rule, October 21, 2015

HUD has published a proposed rule in the October 21, 2015 Federal Register titled, "Quid Pro Quo and Hostile Environment Harassment and Liability for Discriminatory Housing Practices Under the Fair Housing Act." This proposed rule will formalize standards for use in investigating and adjudicating alleged harassment on the basis of race, color, religion, national origin, sex, familial status or disability under the Fair Housing Act.   The comment due date for the proposed rule is December 21, 2015.   While Title VII of the Civil Rights Act prohibits illegal harassment in employment, no standards have been formalized for assessing claims of harassment under the Fair Housing Act. Courts have often applied standards first adopted under Title VII to evaluate claims of harassment under the Fair Housing Act (FHA), but such standards are not always the most suitable for assessing claims of harassment in housing discrimination cases given the differences between harassment in the workplace and harassment in or around one s home. As described in the proposed rule, "One s home is a place of privacy, security, and refuge (or should be), and harassment that occurs in or around one s home can be far more intrusive, violative, and threatening than harassment in the more public environment of one s workplace. The Supreme Court has historically recognized that individuals have heightened rights within the home for privacy and freedom from unwelcome speech, among other things.   In addition to formalizing standards for assessing claims of harassment under the FHA, the regulation is intended to clarify when housing providers and other covered entities or individuals may be held directly or vicariously liable under the Act for illegal harassment or other discriminatory housing practices.   The rule defines "quid pro quo" and "hostile environment harassment" as conduct prohibited under the FHA, and describes the type of conduct that may establish a claim.   The Proposed Rule   The proposed rule would amend 24 CFR part 100 to establish a new subpart H, entitled, "Quid Pro Quo and Hostile Environment Harassment."   Quid Pro Quo & Hostile Environment Harassment   Any person who claims to have been injured or believes such person will be injured by prohibited harassment is an aggrieved person under the FHA, even if that person is not directly targeted by the harassment. For example, a property manager awards an apartment to an applicant in exchange for sexual favors. Other applicants, who were denied the apartment due to the manager s provision of the apartment based on sexual favors, are aggrieved persons.   Quid Pro Quo Harassment   Quid pro quo ("this for that") harassment occurs when a person is subjected to an unwelcome request or demand because of race, color, religion, national origin, sex, familial status or disability, and submission to the request or the demand is, either explicitly or implicitly, made a condition related to his or her housing.   The theory has most typically been associated with sex. For example, quid pro quo harassment occurs when a housing provider conditions a tenant s continued housing on the tenant s submission to unwelcome requests for sexual favors. A person s conduct may constitute quid pro quo harassment even when the victim acquiesces or submits to the unwelcome request or demand.   Hostile Environment Harassment   Hostile environment harassment occurs when unwelcome conduct is sufficiently severe or pervasive as to create an environment that unreasonably interferes with the availability, sale, rental, use or enjoyment of a dwelling, the provision or enjoyment of facilities or services relating to the housing, or the availability or terms of residential real estate-related transactions. Claims of hostile environment harassment should be evaluated from the perspective of a reasonable person in the aggrieved person s position.   Establishing hostile environment harassment requires a showing that: A person was subjected to unwelcome spoken, written or physical conduct; the conduct was because of a protected characteristic; and the conduct was, considering the totality of circumstances, sufficiently severe or pervasive that it unreasonably interfered with or deprived the victim of his or her right to use and enjoy the housing or to exercise other rights protected by the FHA.   Totality of the Circumstances   Factors to be considered in determining whether a hostile environment exists include, but are not limited to: The nature of the conduct; The context in which the conduct occurred; Will consider factors such as whether the harassment was in or around the home; Whether the harassment was accomplished by use of a special privilege of the perpetrator (e.g., using a passkey or gaining entry by reason of the landlord-tenant relationship); Whether a threat was involved; and Whether the conduct was likely to or did cause anxiety, fear or hardship. The severity, scope, frequency, duration, and location of the incident(s); and The relationship of the persons involved.   It is particularly important to consider the place where the conduct occurred. In a case decided under the Equal Protection Clause of the Constitution, the Supreme Court described the sanctity of the home as follows: "Preserving the sanctity of the home, the one retreat to which men and women can repair to escape from the tribulations of their daily pursuits, is surely an important value." "The State s interest in protecting the well-being, tranquility, and privacy of the home is certainly of the highest order in a free and civilized society." When harassment occurs in and around the home, the victim has little opportunity to escape it short of moving or staying away from the home - neither of which should be required. As one court noted in a sexual harassment case under the FHA, the home is a "place where one is entitled to feel safe and secure and need not flee." (Quigley v. Winter, 8th Cir. 2010). Because of the importance of the home, the proposed rule states that "the same or similar conduct may result in a violation of the Fair Housing Act even though it may not violate Title VII." This indicates HUD intent to establish a lower threshold to show hostile environment under the FHA that that required for employment.   The proposed rule provides that the absence of psychological or physical harm is not required in determining whether hostile environment harassment has occurred. However, the severity of psychological or physical harm may be considered in determining the proper amount of any damages to which an aggrieved person may be entitled.   Type of Conduct   Prohibited quid pro quo harassment and hostile environment harassment require unwelcome conduct. Such conduct may be written, verbal or other conduct and does not require physical contact. Examples include threatening imagery (e.g., cross burning or swastika), damaging property, physical assault, threatening physical harm, or impeding the physical access of a person with a mobility impairment. Unwelcome conduct can be spoken or written, such as requests for sexual favors. It may include gestures, signs, and images directed at the aggrieved persons. It may include the use of racial, religious or ethnic epithets, derogatory statements or expressions of a sexual nature, taunting or teasing related to a person s disability, or threatening statements. The unwelcome conduct may involve the use of email, text messages or social media.   An individual violates the Act so long as the quid pro quo or hostile environment harassment is because of a protected characteristic, even if he or she shares the same protected characteristic as the targeted person.   With respect to sexual harassment, harassing conduct need not be motivated by sexual desire in order to support a finding of illegal discrimination. Sexually harassing conduct must occur "because of sex." For example, conduct motivated by hostility toward persons of one sex; conduct that occurs because a person acts in a manner that conflicts with gender-based stereotypes of how persons of a particular sex should act; or conduct motivated by sexual desire or control.   Number of Incidents   A single incident can constitute an illegal quid pro quo, or, if sufficiently severe, a hostile environment. In Quiqley v. Winter, the court cited as a quid pro quo violation the implication by a landlord that the return of a security deposit depended on seeing the plaintiff s nude body or receiving a sexual favor. The court also stated that touching of an intimate area of a plaintiff s body is conduct that can be sufficiently severe to create a hostile housing environment - even if it was an isolated incident.   Establishing Liability for Discriminatory Housing Practices   Direct Liability   A person is directly liable for failing to take prompt action to correct and end a discriminatory housing practice by that person s employee or agent where the knew or should have known of the discriminatory conduct. The proposed rule also states that a person is directly liable for failing to fulfill a duty to take prompt action to correct and end a discriminatory housing practice by a third party (i.e., a non-agent) when the person knew or should have known of the discriminatory conduct.   With respect to a person s direct liability for the actions of an agent, the law recognizes that a principal who knows or should have known that his or her agent has engaged in or is engaging in unlawful conduct and permits it to continue is complicit in or has approved the discrimination. With regard to direct liability for the conduct of a non-agent, the traditional principle of liability that a person is directly liable under the Act for harassment perpetrated by non-agents if the person knew or should have known of the harassment, had a duty to take prompt action to correct and end the harassment, and failed to do so or took action that he or she knew or should have known would be unsuccessful in ending the harassment. For example, an owner may be liable for acts of tenants and management s children after failing to respond to a tenant s complaints of harassment (see Neudecker v. Boisclair Corp., 8th Cir. 2003). This indicates that management will be held liable for tenant-on-tenant harassment if they know of the harassment and fail to take action. It is important to note however, that not every quarrel among neighbors amounts to a violation of the FHA.   Corrective actions appropriate for a housing provider to use to stop tenant-on-tenant harassment might include verbal and written warnings; enforcing lease provisions to move, evict or otherwise sanction tenants who harass or permit guests to harass; issuing no trespass orders or reporting conduct to the police; and establishing an anti-harassment policy and complaint procedure. When the perpetrator is an employee of the housing provider, corrective actions might include training, warnings, or reprimands; termination or other sanctions; and reports to the police. The housing provider should follow up with the victim of the harassment after the corrective action is taken to ensure that it was effective.   The "knew or should have known" concept of liability is well established in civil rights and tort law. A principal "should have known" about the illegal discrimination of the principal s agent when the principal is found to have had knowledge from which a reasonable person would conclude that the agent was discriminating. For example, if a housing provider s male maintenance worker enters female tenants units without notice using a passkey, and enters their bedrooms or bathrooms while they are changing or showering and exposes himself, and the tenants complain about this conduct to the manager, the manager has reason to know that unlawful discrimination may have occurred. If the manager conveys this information to the owner, neither the owner nor the manager takes any corrective action, they are both liable for violating the FHA. In such as case, the principal is liable as if the principal had committed the act.     Vicarious Liability   A person is vicariously liable for the discriminatory housing practices of his or her agents or employees based in "agency law." Under agency law, a principal is vicariously liable for the actions of his or her agents taken within the scope of their relationship or employment, as well as for actions committed outside the scope of the relationship or employment when the agent is aided in the commission of such acts by the existence of the agency relationship. Unlike direct liability, someone may be vicariously liable for the acts of an agent regardless of whether the person knew of or intended the wrongful conduct or was negligent in preventing it from occurring. To be vicariously liable, an agency relationship must exist.   Unlike Title VII, the "affirmative defense" against vicarious liability does not apply to fair housing, and no known court case has extended the Title VII affirmative defense to fair housing claims. Under Title VII, an employer may avoid vicarious liability by showing that the employer exercised reasonable care and took corrective action, and that the victim failed to take advantage of administrative options to address the issue. In the housing context, whether the perpetrator is a property manager, mortgage loan officer, a realtor or a management company s maintenance person, a housing provider s agent holds an unmistakable position of power and control over the victimized home seeker or resident. For example, a property manager can recommend (or sometimes even initiate) the eviction or a harassment victim or refuse to renew a lease, while a maintenance employee may withhold repairs to a victim s apartment or may access the victim s apartment without proper notice or justification.   This proposed rule is the first comprehensive guidance from HUD regarding the issue of harassment, and will have a significant impact on fair housing harassment cases in the future - especially those relating to sexual harassment. I would expect publication of the Final Rule sometime in the spring or summer of 2016, but even without a Final Rule, the guidance is important and will impact how harassment complaints are dealt with by HUD going forward.    

Eligible Basis: IRS Reconciliation of Allowable Costs

During an audit, a primary point of examination by the IRS will be the reconciliation of eligible basis, and identification of large, unusual or questionable items.   Reconciliation of Eligible Basis   The eligible basis shown on Line 7 of the 8609 and Line 1 of the 8609-A should match. If they don t, taxpayers must be prepared to explain why.   Section 42(m)(2) requires that housing credit agencies not allocate more credit to a project than the amount necessary for the financial feasibility of the project. To ensure this, the state agency is required to evaluate the need for the credit at three separate points of the development process: (1) when the credits are initially applied for; (2) when the credit allocation is made; and (3) when the building is placed in service. This final evaluation (placed in service) must occur no later than the date the state agency issues the 8609s for the project. Prior to obtaining an 8609, owners are required to submit a cost certification. If the project has more than ten units, a CPA must do the cost certification; for projects of 11 units or less, the state agency may require that a CPA prepare the certification. The eligible basis shown on the cost certification should match the eligible basis on the 8609 and 8609-A.   Requirements of the Cost Certification   At a minimum, the final cost certification must include the following: All costs, including those that will be in eligible basis and those that will not be in eligible basis. In addition to basic construction costs, the following must be included in the certification: Site acquisition costs; Construction contingency; General contractor s overhead and profit; Architect s and engineer s fees; Permits and survey fees; Insurance premiums; Real estate taxes during construction; Title and recording fees; Construction period interest; Financing fees; Organizational costs; Rent-up and marketing costs; Accounting and auditing costs; Working capital and operating deficit reserves; Syndication and legal fees; and Developer fees   If an existing building is bought and rehabilitated, the acquisition costs for the building must be shown separately from the rehab costs and must be distinguished from the cost of the land. Large, Unusual or Questionable Items (LUQs)   During an examination, the IRS will look for specific costs that are large, unusual or questionable. The agent will: Consider the inherent character of the cost categories. They will ensure that categories not includable in eligible basis, such as the cost of land, were not shown in eligible basis on the cost certification; Consider the beneficial effects of how an item was reported. For example, allocation of the purchase price of an existing building between the building and the land. Another example would be the case of a multiple building project. Unless the actual costs associated with each building were tracked and cost certified, the total eligible basis for the entire project should be allocated among the buildings based on square footage; Consider costs that should have been in the final cost certification, but were not. Examples include partnership organizational costs, rent-up and marketing costs, and syndication fees. Even though not includable in eligible basis, these costs must be accounted for in order to ensure that such costs have not be "hidden" among allowable cost items; and Consider line items on the cost certification that are an accumulation of a larger number of separate costs. In such cases, the taxpayer will be required to explain any underlying costs.   Even when all items that are clearly excludable have not been placed into basis, the IRS will focus on two additional issues: The comparative size of the cost to total eligible basis; and The absolute size of the cost, even if comparably small, if the dollar value does not appear commensurate with the character of the cost.   Because of the importance of the cost certification to the final establishment of eligible basis, it is important that developers of LIHTC projects retain the services of accountants skilled in the LIHTC program. Issues of eligible basis are unique to the tax credit program, and only accounting firms that specialize in the Section 42 program should be used for the preparation of cost certifications.  

Short Term Rental Fees for Vouchers

In Velez v. Cuyahoga Metropolitan Housing Authority, 2015 U.S. App. Lexis 13265 (6th Cir. July 30, 2015), an appeals court ruled that fees for short-term rentals are considered rent and must be paid as part of the rent under the Housing Choice Voucher (HCV) Program.   The plaintiffs in the case entered into one-year leases with a landlord. At the end of the one-year lease, the leases were renewed for terms of less than one-year. The landlord had a policy that when leases are not at least one year, tenants are required to pay additional fees. These fees ranged from $35 to $100 per month.   The policy of the Cuyahoga Metropolitan Housing Authority (CMHA) was not to treat such short-term fees as rent under the HCV program, but considered them to be "convenience fees" charged as consideration for the increased costs associated with the administration of leases with shorter term rentals. For this reason, the tenants were required to pay the fees out-of-pocket.   The plaintiffs filed a claim in district court against CMHA, arguing that the short-term fees were "rent." The district court ruled in favor of CMHA, stating that the term "rent" under the U.S. Department of Housing & Urban Development (HUD) regulations does not include the fees that landlords charge for short-term leases. The plaintiffs then appealed to the U.S. Court of Appeals for the Sixth Circuit.   The appeals court relied on Section 8 of the Housing Act of 1937 and other HUD regulations in reaching its decision. Under the Act, housing assistance payments that a PHA makes on behalf of a low-income tenant are defined as the monthly assistance payment by the PHA, which includes a payment to the owner for rent to the owner under the family s lease. HUD regulations define "rent to owner" as "total monthly rent payable to the owner under the lease for the unit. Rent to owner covers payment for any housing services, maintenance and utilities that the owner is required to provide an pay for."   "Based on the plain meaning of the word in context, rent in Section 8 of the U.S. Housing Act means the amount paid under the lease for use and occupancy of the property," the appellate court wrote. "Because the subject fees are an expense payable by the lessees for the occupancy of the rental unit, we conclude that the expenses are part of the lessees rent under the Act." Based on this, the CMHA is required to pay the short-term rental fees charged to the plaintiffs. This assumes that the fees, when combined with other rent charged, do not exceed the HCV payment standard approved for the locality.   This is an important court ruling in that it stipulates that not only may owners participating in the HCV program charge additional rent for short-term rentals, but that PHAs are obligated to include the fees as rent when determining the PHA portion of the rent. This is the case as long as the rental amount does not exceed the local payment standard for the HCV program.    

Costs Included In Eligible Basis

  The next few articles in this series of articles on the IRS Audit Guide will focus on the important issue of Eligible Basis, the beginning point for the calculation of credits. This first article will discuss the costs that may be included in eligible basis.   In any examination of eligible basis, the IRS examiner will begin with an analysis of the actual qualifying costs incurred by the taxpayer. It is the responsibility of the taxpayer's accountant (usually the accountant who completes the cost certification) to determine the items to be included in the determination of eligible basis.   Defining Eligible Basis   Eligible basis is primarily defined by 103 and 168 or the IRC, with additional clarification in 42.   Under 42(d)(4)(A), to be included in eligible basis, a cost must be related to a "residential rental property." The term 'residential rental property' has the same meaning for 42 as it does for IRC 103 (Private Activity Tax-Exempt Bonds). Essentially, a residential rental project consists of buildings or structures, together with any functionally related and subordinate facilities. A building or structure is a "discrete edifice or other man-made construction consisting of an independent foundation, outer walls, and roof. A single unit which is not an entire building but is merely a part of a building" is not a building or structure for purposes of 42.   IRS Notice 88-91 further explains that buildings include apartment buildings, single-family dwellings, townhomes, row houses, a duplex, or a condominium. Housing owned by a cooperative housing corporation or a tenant-stockholder is not included in this definition.   Buildings that may qualify for the credit include: >new buildings; >existing buildings; and >rehabilitation expenditures on an existing building.   Costs included in eligible basis must be depreciable property under ITC 168. For this reason, land may not be included in eligible basis, since land does not depreciate (i.e., it does not diminish in value over a period of time).   IRC 168(e)(2)(A) defines 'residential rental property' to mean any building or structure if 80% or more of the gross rental income from such building or structure for the taxable year is rental income from dwelling units, not including units in a hotel, motel, or other establishment if more than half the units are used on a transient basis. Also, depreciable residential rental property expensed under IRC 179 may not be included in eligible basis.   Residential Rental Unit   A unit is defined in Treasury Reg. 1.103-8(b)(8)(i) to mean "any accommodation containing separate and complete facilities for living, sleeping, eating, cooking, and sanitation". Such accommodations may be served by centrally located equipment, such as air conditioning or heating. Thus, for example, an apartment containing a living area, a sleeping area, bathing sanitation facilities, and cooking facilities equipped with a cooking range, refrigerator, and sink, all of which are separate and distinct from other apartments, would constitute a unit.   Single room occupancy (SRO) units also qualify as residential rental units even though the units may provide eating, cooking and sanitation facilities on a shared basis.   Common Areas   Eligible basis includes the cost of common areas provided as comparable amenities to all residential rental units in a building. These are facilities for use by the tenants, and other facilities reasonably required by the project.         Community Service Facilities   The eligible basis of any building located in a qualified census tract (QCT) includes the adjusted basis of any property used to provide services for certain nontenants. These are known as "community service facilities," and must (1) be located in a QCT, (2) serve primarily individuals whose income is 60% or less of area median income, and (3) used throughout the taxable year as a community service facility. Also, any fees charged for the services provided in the facility must be affordable to persons at or below the 60% income level, and the need for the services should have been stipulated in the project's market study.   Transitional Housing & Supportive Services for the Homeless   If a project provides transitional housing for the homeless, the portion of the building used to provide supportive services may be included in eligible basis. To qualify as transitional housing: (1) the building must be used exclusively to facilitate the transition of homeless individuals (as defined in the McKinney-Vento Homeless Assistance Act) to independent living within 24 months, and (2) a governmental entity or nonprofit organization provides the individuals with temporary housing and supportive services designed to assist such individuals in locating and retaining permanent housing. No more than 20% of the building can be used for supportive services.   Functionally Related Facilities   Facilities that are functionally related and subordinate to residential rental projects may be included in eligible basis. Examples of such spaces are swimming pools, recreational facilities, parking areas, and other facilities reasonably required by the project (e.g., heating & cooling equipment, trash disposal equipment, and units for resident employees.   Landscaping & Land Improvements   If costs associated with land preparation are so closely associated with a depreciable asset so that it will have to be replaced at the same time as the depreciable asset, such costs may be included in eligible basis.   Date of Determination   For a new building, the eligible basis is the adjusted basis as of the close of the first taxable year of the credit period. The same rule applies for existing buildings, but there are additional rules. The rule also applies to rehab expenses treated as a separate new building, but only if the "minimum expenditure" test has been met.   In future articles on eligible basis, I will discuss >How the IRS Reconciles Eligible Basis and Identifies "Large, Unusual, or Questionable" Items; >How the IRS Verifies Assets Included in Eligible basis; >Specific Issues Relating to Common Areas, Required Facilities, and the Provision of Services; and >Developer Fees  

No Increase in 2016 Social Security Rates

The federal government announced today that the Social Security Cost of Living Adjustment (COLA) for 2016 will be zero. This means that there will be no change in the Social Security income of SS recipients for the upcoming year. Owners and managers of properties that are required to determine the income of residents should use the current SS rate when projecting the income of applicants and residents. This also affects persons receiving SSI, VA pensions, Civil Service Pensions and Railroad Retirement.

Taxpayer Removal from the Program - The Section 42 Death Penalty

Taxpayer Removal from the Program - The Section 42 Death Penalty   IRS Treasury Regulation 1.42-5(e)(3) provides authority for the state agency to report to the IRS that a building is "no longer in compliance nor participating in the IRC 42 program." This report is made on IRS Form 8823.   If an Agency reports on the 8823 that a building is entirely out of compliance and will not be in compliance at any time in the future, no further compliance monitoring is required of the state agency. Keep in mind however, the that Extended Use Agreement will still be in effect in most cases, and enforceable by the state agency.   In most cases, there is no correction for this finding, as noted by the fact that the relevant line on the 8823 (11p) has no correction box.   Returned Credits   Under certain circumstances, previously allocated low-income housing credits may be returned to the state agency. Under Treasury Regulation 1.42-14(d)(2)(ii), these credits may be returned up to 180 days following the close of the first tax year of the credit period. These credits are returned to the state s credit ceiling and may be reallocated to another qualified low-income project. If the entire credit is returned, and 8609s have been issued by the Agency, the 8823 is used to notify the IRS that the credit has been returned. Treas. Reg. 1.42-14 specifies the four possible reasons for the return of the allocated credit:   The building is not placed in service within the required time period or fails to meet the minimum set-aside requirements of 42(g)(1) by the close of the first year of the credit period; The building does not comply with the terms of the allocation. The terms of the allocation are the written conditions agreed to by the state agency and the allocation recipient in the allocation document. Note that this is generally the only time credit can be removed for an Extended Use Agreement violation; The owner and state agency mutually agree to cancel an allocation of credit; and The Agency determines that the amount of credit allocated to a project is not necessary for the financial feasibility of the project throughout the credit period.   E.g., the end of the tax year for a project is December 31, 2015. The state agency determines (no later than June 28, 2016) that the property is not complying with the requirements of the Extended Use Agreement. The entire amount of credit may be removed from the project and returned to the Agency.   Noncompliance During the 15-Year Compliance Period   Typical issues that may justify a state agency s determination that a taxpayer is no longer participating in the program include: Egregious noncompliance; i.e., conspicuous, flagrant, and systemic in nature and includes the failure to make reasonable attempts to comply with the requirements of the program; Careless, reckless, or intentional disregard of program requirements; The taxpayer s voluntary withdrawal of the building from the 42 program, while still retaining ownership. E.g., the owner converts all units to market rate; The owner fails to respond to repeated notices for monitoring reviews; or The owner repeatedly fails to submit annual reports and owner certifications.   Once a building is removed from the program, credit associated with the building is disallowed, and recapture of a portion of prior claimed credit may occur.   Reinstatement into the Program   Only the state agency that allocates credits to a project can reinstate that project to the tax credit program. This could occur if: The owner brings the building back into compliance. If the state permits it, the taxpayer may resume claiming credits if the noncompliance is corrected and the credit is otherwise allowable; or A new owner acquires the project, brings it back into compliance, and wishes to participate in the program.   If a building is reinstated to the program, the taxpayer will be required to provide documentation proving the date the building was reinstated. The owner will be required to demonstrate that: The original noncompliance issues that resulted in the state agency s determination have been resolved; The Extended Use Agreement is in effect and recorded as a restrictive covenant; All required certifications have been filed with the state agency for each taxable year beginning with the year of reinstatement; and The state agency has resumed compliance monitoring activities.   While removal from the LIHTC program is rare, it does happen. What is important for owners of tax credit properties to be aware of is that such removal is completely within the authority of the state agency, and that only the state agency can return a property to the program once removed.  

Allocations Under the Nonprofit Set-Aside - IRS Requirements

IRC Section 42(h)(5) requires that a portion of each states annual credit ceiling be set aside for allocation to projects involving qualified nonprofit organizations. Specifically, the Code requires that not more than 90% of the state housing credit ceiling for any calendar year be allocated to projects other than qualified low-income housing projects involving qualified nonprofit organizations. The qualified nonprofit must own an interest in the project and materially participate in the development and operation of the project throughout the 15-year compliance period.   Qualified Nonprofit Organization   For purposes of 42, a qualified nonprofit must Be exempt from tax under 501(a) of the Internal Revenue Code (IRC); Be unaffiliated with or controlled by a for-profit organization; and Have as one of its purposes the fostering of low-income housing.   Audit Issues for the IRS   During an audit of a property allocated credits under the Nonprofit set-aside, the following issues will be examined: Whether the nonprofit is a qualifying nonprofit organization and satisfies the requirements for its tax-exempt purpose; Whether the nonprofit has maintained an ownership interest in the project; and Whether the nonprofit materially participated in both the project development and operation throughout the 15-year compliance period.     The Nonprofit Set-Aside   Even if a nonprofit is a partner in the partnership under audit, unless the credits were allocated from the nonprofit set-aside, the taxpayer is not subject to the requirements of 42(h)(5), and the requirements relating to the set-aside will not be an audit issue.   Qualified Tax-Exempt Organization   Allocations under the nonprofit set-aside are frequently made to partnerships for which the General Partner is a qualifying nonprofit organization. One of the issues the IRS will carefully examine is whether one of the nonprofit s exempt purposes includes the fostering of low-income housing. IRS guidance provides that the fostering of low-income housing serves a "charitable purpose," which is a requirement for a nonprofit organization.                   Revenue Procedure 96-32 provides guidance (including a "safe harbor") for determining whether a qualified nonprofit organization under IRC 501(c)(3) involved in low-income housing is pursuing a charitable purpose by fostering low-income housing. The safe harbor determination is based on the percentage of low-income units and the income level of the tenants. A qualified nonprofit organization must establish (for each project) that at least 75% of the units are occupied by residents whose incomes are 80% or less of the Area Median Income (AMI), and either 40% of the units are occupied by residents whose incomes are 60% or less of the AMI, or 20% of the units are occupied by residents whose incomes are 50% or less of the AMI. This determination can be based on the resident s income at the time the household moves into the low-income unit.   Ownership Test   The nonprofit must have an ownership interest in the low-income housing project throughout the 15-year compliance period. A qualified nonprofit organization can own an interest directly, or through a partnership, or own stock in a qualified corporation that owns directly, or through a partnership, a low-income housing project. A qualified corporation must be a corporation that is 100% owned at all times during its existence by one or more qualified nonprofit organizations.   Material Participation   IRC 469(h) defines material participation as activity that is regular, continuous, and substantial. The test applicable to nonprofit organizations for purposes of material participation is the "facts and circumstances" test. Generally, the IRS will apply the following guidelines in defining material participation: Material participation is most likely to be established in an activity that constitutes the principal business/activity of the taxpayer; Involvement in the actual operations of the activity should occur. The services must be integral to the operations of the activity. Simply consenting to someone else s decisions or periodic consultation relative to general management decisions is not sufficient; Participation must be maintained throughout the year; Regular on-site presence at operations is indicative of material participation; and Providing services as an independent contractor is not sufficient.   In many cases, the owning partnership includes both a nonprofit and a for-profit entity. Such partnerships are often structured so that the nonprofit is a general partner with a 1% or less interest in the partnership and the for-profit investor(s) are limited partners with a combined ownership interest of 99% or more.   If the partnership has one or more for-profit general partners, the nonprofit partner may have less participation in the partnership, which raises the issue of whether the nonprofit s participation is the project is substantial, and thus material.     Exempt Status and Private Inurement   The nonprofit and for-profit general partner should not be related parties, i.e., share officers or board of directors. Such associations may call into question the exempt status of the nonprofit entity. The issue being - whether the nonprofit entity acts exclusively in furtherance of a charitable purpose or to further the interests of private investors. Some indicators that the nonprofit is not acting exclusively to further a charitable purpose are: The nonprofit is not the only general partner; The nonprofit s minority partnership interest provides for minimal participation in the project s operation; The nonprofit makes guarantees to the limited partners against loss of low-income housing credits; and Excessive private benefits result from real property sales, development fees, or management contracts.   Audit Adjustments   The 42 credit may be disallowed in its entirety if a taxpayer fails to comply with 42(h)(5)(B) requirements. Failure to comply does not, in and of itself, result in an actual (or imputed) decrease in the qualified basis of the building. Therefore, the credit recapture provisions of the Code are not applicable. The taxpayer may claim credit for the taxable year that the violation is corrected.   Compliance will be determined "as of the close of the taxable year." If a taxpayer is found to be compliant "as of the close of the taxable year" in which the noncompliance first occurred, there is no disallowance of credit.   Correction within a Reasonable Period   If the noncompliance is not corrected "as of the end of the taxable year in which the noncompliance occurred," when and if credits are reduced will be dependent on who is responsible for the noncompliance. If responsibility does not rest solely with the nonprofit organization, no credit is allowable for the taxable year the noncompliance occurred or any subsequent taxable year until the noncompliance is corrected. If responsibility rests solely with the nonprofit organization, correction within a "reasonable period" will prevent any credit loss. The IRS will apply the same test for "reasonable period" in this case as is applied in the event of a casualty loss. No longer than two years following the end of the tax year in which the noncompliance first occurred. If the noncompliance is corrected within this reasonable period, there is no disallowance of credit. If the noncompliance is not corrected within this timeframe, no credit is permitted for the tax year the noncompliance occurred or any subsequent taxable year until the noncompliance is corrected.         Related Issues Federal Financing: Nonprofit organizations often secure federal financing and then loan the proceeds to the owning partnership (the taxpayer). In order to avoid potential basis issues, the loan should be bona fide debt and not a grant. Developer Fee: If the nonprofit takes a developer fee from the project, the IRS will confirm that the nonprofit has the expertise to develop the project, and did in fact, develop the project. Private Inurement: A developer fee paid to the nonprofit that may be used in whole or in part for the benefit of private persons may call into question whether the entity is being operated "exclusively" for an exempt purpose, which in turn, may jeopardize the tax-exempt status of the entity. Unrelated Business Taxable Income: the developer fee may be subject to taxation under IRC 512 and if the nonprofit entity has an excess of taxable income, the entities tax-exempt status could be jeopardized.   Summary   When developing LIHTC projects with credits from a States nonprofit set-aside, strict consideration must be given to issues relating to material participation, maintaining the presence of a qualified nonprofit with an ownership interest and private inurement.