On Tuesday, February 26, 2019, the IRS will publish in the Federal Register a final regulation on how state Housing Finance Agencies (HFAs) must monitor low-income housing tax credit (LIHTC) properties for compliance with the requirements of Section 42 of the Internal Revenue Code.
This final regulation amends the compliance monitoring regulations concerning the LIHTC program, and revise and clarify the requirement to conduct physical inspections and review low-income certifications and other documentation. This final regulation replaces the temporary regulation that was issued on February 25, 2016 and amends 26 CFR part 1 to finalize rules relating to IRC Section 42.
Under the temporary regulation and Revenue Procedure 2016-15, it was determined that the HUD Real Estate Assessment Center (REAC) protocol satisfies the Section 42 physical inspection requirements. The Revenue Procedure provides that, in a LIHTC project, the minimum number of low-income units that must undergo physical inspection is the lesser of 20 percent of the low-income units in the project, rounded up to the nearest whole number of units, or the number of low-income units set forth in the Low-Income Housing Credit Minimum Unit Sample Size Reference Chart in the revenue procedure (the requirements will be outlined in this article). This same requirement applies to the number of files that have to be reviewed.
Revenue Procedure 2016-15 also provided an exception to the requirement that at least one unit in each building be inspected. Under the procedure, the all-buildings requirement does not apply to an agency that uses the REAC protocol to satisfy the physical inspection requirement.
Finally, the temporary regulations decoupled the physical inspection and low-income certification review and ended the same units requirement. An HFA is no longer required to conduct a physical inspection and file review of the same unit. In addition, an Agency may choose a different number of units for physical inspection and for file review provided the Agency chooses at least the minimum number of low-income units. Further, an Agency may choose to conduct a physical inspection and file review at different times.
This final regulation makes a number of important changes from the Temporary Regulation and Revenue Procedure and will significantly alter how HFAs monitor LIHTC properties for compliance.
Provisions of the Final Regulation
1. The final regulations remove the rule that allows minimum sample size to be the lesser of 20-percent of the total number of low-income units or the minimum unit sample size set forth in the Low-Income Housing Credit Minimum Unit Sample Size Reference Chart. The final requirement is that HFAs must inspect no fewer units than the number specified for projects of the relevant size as set forth in the Low-Income Housing Credit Minimum Unit Sample Size Reference Chart. Agencies have discretion to inspect and review more units as they see fit.
2. The “all-buildings” rule is retained in the final regulation except for properties that undergo REAC inspections. The IRS does is concerned that HFAs may not all have inspectors as well-trained as the HUD-approved REAC inspectors and is therefore requiring a physical inspection of all buildings when the property is not undergoing a REAC inspection.
3. A major change in the final regulation is the “reasonable notice time frame.” The temporary regulations provide that reasonable notice is generally no more than 30-days, but they also provide a very limited extension for certain extraordinary circumstances beyond an Agency’s control such as natural disasters and severe weather conditions. These final regulations shorten the reasonable notice requirement to a 15-day notice that a project will experience an upcoming physical inspection or file review.
The reason for this shortened timeframe is that the validity of an inspection sample would be destroyed if a project owner had an opportunity to selectively prepare the units in the sample for inspection. For this reason, an HFA must select the low-income units to inspect in a manner that will not give advance notice that a particular low-income unit will or will not be inspected. Accordingly, the final regulations clarify that an Agency may notify the owner of the particular low-income units for inspection only on the day of the inspection. As noted in the regulation, under the REAC protocol, HUD or HUD-certified REAC inspectors randomly select low-income units for inspection on the day of the inspection; HFAs are now required to do the same.
4. Treatment of scattered site or multiple buildings with a common owner and plan of financing. While a number of industry practioners recommended that in the case of scattered site or multiple buildings with common ownership and financing, the HFA be able to treat the project as a single project for compliance monitoring purposes – regardless of whether or not the owner made the multiple building election on the IRS Form 8609, the final regulation does not adopt this regulation. For compliance monitoring purposes, a project will be defined in accordance with Section 42 – an HFA cannot deem separate buildings to be a project if the 8609 multiple building project election has not been made.
5. All HFAs are required to amend their Qualified Allocation Plans (QAP) to include the requirements of this final regulation. On the date the QAP is amended, Revenue Procedure 2016-15 will be considered obsolete. QAPs must be amended no later than December 31, 2020.
6. The number of low-income units to be inspected and the number of low-income files to be reviewed may not be fewer than the numbers shown below:
Low-Income Units in Project Minimum Units to Review
7. Random Selection Requirements: Agencies generally may not select the same low-income units of a low-income housing project for on-site inspections and file reviews, because doing so would usually give prohibited advance notice. This is a complete reversal of the original requirement that the units for physical inspection and file review be the same. The units must select the units for inspections or low-income certification review separately and in a random manner.
8. Meaning of Reasonable Notice: the 15-day notice period begins on the date the Agency informs the owner that an on-site inspection of a project and low-income unit file review will occur. Notice of more than 15-days, however, may be reasonable in extraordinary circumstances that are beyond an Agency’s control and that prevent an Agency from carrying out within 15-days an on-site inspection for file review. Extraordinary circumstances include, but are not limited to, natural disasters and severe weather conditions. In the event of extraordinary circumstances that result in a reasonable-notice period longer than 15-days, an Agency must still select the relevant units and conduct the same-day on-site inspection or file review as soon as possible.
9. Use of the REAC Protocol: In order to use the inspection requirements relating to the REAC protocol, the inspection must satisfy the following requirements:
(i) Both vacant and occupied low-income units must be included in the population of units from which units are selected for inspection;
(ii) The inspection complies with the procedural and substantive requirements of the REAC protocol, including the requirements of the most recent REAC Uniform Physical Condition Standards (UPCS) inspection software, or software accepted by HUD;
(iii) The inspection is performed by HUD or HUD-Certified REAC inspectors; and
(iv) The inspection results are sent to HUD, the results are reviewed and scored within HUD’s secure system without any involvement of the inspector who conducted the inspection, and HUD makes its inspection report available.
10. HUD Inspections that comply with the requirements of the REAC Protocol: the number of units required to be inspected under the REAC protocol satisfies the requirements of the final regulation concerning the number of low-income units the Agency must inspect. Also, the manner in which the low-income units are selected for inspection under the REAC protocol satisfies the requirements of the final regulation.
11. File Reviews for HUD Inspections that comply with the requirements of the REAC Protocol: An Agency that conducts physical inspections using the REAC protocol if not excused from following the requirements of the final regulations in selecting the files for review.
12. Circumstances under which the same files and units may be chosen for inspection: If an agency chooses to select the same units for on-site inspections and file reviews, the Agency must complete both the inspections and file reviews before the end of the day on which the units are selected.
It is important to note that the final regulation does not include a provision for desk audits of files. The regulation states that the Agency may review the low-income certifications wherever the owner maintains or stores the records (either on-site or off-site).
Clearly this final regulation makes some significant changes to the way HFAs will monitor LIHTC properties for compliance and will require that owners adjust expectations relative to manner in which the reviews will be performed. As noted earlier, all these changes must be in place no later than December 31, 2020.