Employee and Security Units – IRS Audit Guide (October 2014)

The recently released final Section 42 Audit Guide provides some interesting guidance relative to the treatment of employee and security units in a LIHTC project. The Guide confirms that the cost of such a unit is includable in eligible basis, but is excluded from the applicable fraction (essentially making the unit common area). Three key elements are required in order to utilize a unit as an employee or security unit:

1. The services to be provided by the person living in the unit are necessary services;
2. The services could not be properly provided unless the person lives on site; and
3. The employee or security officer is working full-time at the site.

#3 alters to some degree assumptions that have been made in the past regarding security officers. Many security units are occupied by professional law enforcement officers (e.g., police officers, deputy sheriff, etc.). In these cases, the officer is not a full-time employee of the site and may only be on site during certain hours (when they are not engaged in their actual employment). If the IRS intention is to require that such units truly be occupied by persons who are full-time to the site, it will make the utilization of a unit for security purposes very difficult.

The Guide also points out certain elements that are not relevant to an IRS audit, including:

1. Payment of rent, utilities or both by an employee or security does not preclude the unit being considered an employee unit;
2. Units can be “switched,” meaning that the unit initially identified as an employee unit can be switched to another unit; and
3. Employee/security units can become low-income units.

#2 and 3 do not apply to single-family homes with tax credits since those buildings will not have received an allocation of credits.

#1 above presents the most obvious potential change to industry practice – that of not charging employees who reside in employee units. This indicates that the IRS gives more weight to the need for the unit and the services provided than whether or not the employee or security officer is charged for rent or utilities. Even with this guidance, the charging of rent or utilities for an employee unit is still not recommended unless specifically approved by the State Housing Finance Agency.

Issues identified in the Guide as being possible noncompliance relative to employee/security units include:

1. The services provided by the resident are not required by the project.

• An example would be an employee who provides non-housing related services to the residents (examples may be found in IRS Regulation 1.42-11);

2. The employee does not provide services that are specific to the project or provides services to multiple projects. This is the case even if the employee is an income-qualified tenant if the unit is designated as an employee unit. This is because the unit is not available to the general public.

Clearly there are issues presented here that may impact current operations at LIHTC projects. Owners and managers should review their current policies relative to employee or security officer units and ensure that those policies meet with HFA approval. Examples of areas that could now present problems with regard to employee units are

1. Security officers who are not full-time to the property;
2. Employees managing a multiple properties – even if in close proximity to each other; and
3. Charging rent or utilities that are not approved by the State HFA.