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:

 

1. 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;
2. 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;
3. The owner and state agency mutually agree to cancel an allocation of credit; and
4. 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.