Annual Owner Certifications: Understanding the Basics of LIHTC Compliance

Site owners, at least annually, for each year of a site's 15-year compliance period, are required to certify to the state housing agency that the LIHTC site was operated in compliance, for the preceding 12-month period, with Internal Revenue Code (IRC) Section 42 requirements. This annual owner certification is a requirement of Treasury Regulations 1.42-5 paragraph (c)(1).

As the end of the calendar year approaches, site owners can expect your state housing agency to send an annual certification form. Most state agencies define “annual period” as the calendar year, with due dates for submission. The owner is supposed to complete the form, sign it to certify that the information on it is correct and the site complies with the tax credit law, and send the form back.

Once submitted, the state agencies review the certifications. And the owner is considered to be in noncompliance if the certification is inaccurate, incomplete, or the owner discloses noncompliance with any of the 12 specific requirements listed in the certification.

We’ll cover the 12 certifications owners must make to the state housing agency. Reviewing these items will also provide a useful overview of the basics of LIHTC compliance. These certifications cover every major aspect of tax credit compliance, including meeting the minimum set-aside and applicable fraction requirements, restricting rents, addressing changes in the eligible basis, complying with the vacant unit and next available unit rules, and complying with fair housing rules.

12 CERTIFICATION REQUIREMENTS

Your specific state agency's annual certification of continuing program compliance may include fewer or more than 12 certifications. Since each agency designs its own form, your state's agency may group the information in the 12 required certifications differently. Also, the agency may want owners to certify to more information, such as whether their sites' ownership or management changed over the year. The following are the 12 specific requirements that Treasury Regulation Section 1.42-5(c)(1) says must be addressed in the certification:

Minimum Set-Aside

Owners must certify that the site met the minimum set-aside. The minimum set-aside is a percentage that determines the minimum number of units at your site or building that the owner must rent to qualified low-income households.

All tax credit site owners must formally notify the IRS of their minimum set-aside election for their building or site when they file IRS Form 8609. The minimum set-aside is expressed as two numbers, separated by a hyphen. For example, the numbers may be 20-50 or 40-60. The first number indicates the percentage of units at your site that you must rent to qualified low-income households. The second number refers to the highest income these households can earn to be qualified, expressed as a percentage of area median gross income (AMGI). For example, if your set-aside is 40-60, then you must rent at least 40 percent of your units to households earning no more than 60 percent of AMGI.

The owner may have elected to adhere to the 20-50 minimum set-aside test under Section 42(g)(1)(A); the 40-60 test under Section 42(g)(1)(B); the 25-60 test under Sections 42(g)(4) and 142(d)(6) for New York City; or, if applicable to the site, the 15-40 test under Sections 42(g)(4) and 142(d)(4)(B) for “deep rent-skewed” projects. Another option that was enacted in 2018 is the Average Income Test. it requires that at least 40 percent of the units in the project to be rent-restricted and designated low-income units, and the average unit designation to be no more than 60 percent of area median income (AMI).

Applicable Fraction

Owners must certify that there was no change in the applicable fraction of any building in the project, or if there was, the certification includes a description or explanation. The applicable fraction is the percentage of a building that’s treated as low-income use and generally eligible for the tax credits as of the close of that year of the compliance period. The applicable fraction, unlike the minimum set-aside and other low-income occupancy requirements you may have, depends on the number of low-income units and the size of those units.

Specifically, under Internal Revenue Code (IRC) Section 42(c)(1)(B), the applicable fraction is the smaller of the unit fraction or the floor space fraction. IRC Section 42(c)(1)(C) defines “unit fraction” as a fraction whose numerator is the number of low-income units in the building, and whose denominator is the number of residential rental units in such building. And IRC Section 42(c)(1)(D) defines “floor space fraction” as a fraction whose numerator is the total floor space of the low-income units in such building, and whose denominator is the total floor space of the residential rental units. Floor space includes the entire footprint of the unit, including closets within the unit and balconies attached to the unit for the sole use of the tenants occupying the unit.

Income Recertifications

Owners certify that an annual income certification and documentation to support the certification was received from each low-income tenant. However, note that the Housing and Economic Recovery Act of 2008 (HERA) eliminated the annual income recertification requirement for projects with 100 percent buildings or buildings with low-income housing tax credit units and no market-rate units.

This year, as a result of the pandemic and IRS Notice 2021-12, which halted annual income recertifications until Sept. 30, 2021, you didn’t have to perform an income recertification for some of your existing households in low-income units. But with the impending expiration of IRS Notice 2021-12, you should have started performing annual income recertifications on Oct. 1. This means that for households with an annual recertification due date after Sept. 30, 2021, owners must resume income recertifications as due under Section 1.42-5(c)(1)(iii) of the Income Tax Regulations.

Rent Restriction

Owners certify that all low-income units were rent restricted. Under IRC Section 42(g)(2)(A), a unit qualifies as a low-income unit when the gross rent doesn’t exceed 30 percent of the imputed income limit unit under IRC Section 42(g)(2)(C).

To calculate the rent for your low-income units, you use HUD income limits. These are the same limits you use to determine whether households are qualified. The limits you use depend on the geographic location of your building and the percentage of area median gross income (AMGI) the owner and your state housing agency agreed to apply.

Tax credit rent is based on 30 percent of income limits and not 30 percent of a household’s actual income. To calculate the annual rent, you would multiply the appropriate income limit by 30 percent. Then divide the annual rent by 12 to get the monthly rent. This monthly rent is called the “gross rent” and is the most you can charge a household for rent and utilities.

Fair Housing

Owners must certify that the site complied with fair housing rules. Specifically, owners must certify that all low-income units were for use by the general public, including the requirement that no finding of discrimination under the Fair Housing Act, 42 U.S.C. 3601-3619, occurred for the project. Fair housing is the right to choose housing free from unlawful discrimination. And the FHA is the legislation that protects people from discrimination in housing based on race, color, religion, sex, national origin, familial status, and disability.

A finding of discrimination includes an adverse final decision by the Secretary of the Department of Housing and Urban Development (HUD), 24 CFR 180.680; an adverse final decision by a substantially equivalent state or local fair housing agency, 42 U.S.C. 3616a(a)(1); or an adverse judgment from a federal court.

Suitable for Occupancy

Owners must certify that the buildings and low-income units were suitable for occupancy, taking into account local health, safety, and building codes (or other habitability standards), and the state or local government unit responsible for making local health, safety, or building code inspections didn’t issue a violation report for any building or low-income unit in the project. The suitable for occupancy standard is required for low-income housing tax credits to be claimed.

If any low-income unit at an LIHTC project isn’t suitable for occupancy, the site may become ineligible for continued tax credits, the amount of the tax credit could be reduced, or previously allowed tax credits could be recaptured.

If a violation report or notice was issued by the governmental unit, the owner must attach a statement summarizing the violation report or notice or a copy of the violation report or notice to the annual certification submitted to the agency. In addition, the owner must state whether the violation has been corrected.

Eligible Basis

Owners certify that there was no change in the eligible basis of any building in the site, or include an explanation is with the certification for the change, such as a common area has become commercial space, or a fee is now charged for a tenant facility formerly provided without charge. The eligible basis is the amount of development cost that would be eligible for generating tax credits if all the site’s units are used for low-income housing. The eligible basis of a building is determined at the end of the first year of the credit period, and as long as there’s no reduction in the eligible basis amount upon which the credit is based, the site is in compliance.

When a building’s eligible basis goes down, the credits the owner can claim go down with it. A change in a building’s eligible basis can occur due to an inadvertent conversion of common areas into commercial space.

No Separate Fees

Owners certify that tenant facilities included in the site’s eligible basis, such as swimming pools, other recreational facilities, and other parking areas, were provided on a comparable basis without charge to all tenants in the buildings.

Section 42(d)(4)(B) of the Internal Revenue Code indicates that common areas may be included in eligible basis or credits may be claimed on the cost of the common areas as long as the common area is provided as “comparable amenities to all residential rental units.” This means that you can’t charge anyone for the use of common areas that are included in your building’s eligible basis. If a common area is in the basis, fees may not be charged even to market-rate residents. In other words, if parking, pools, tennis courts, and other types of common areas are included in the eligible basis, no separate fees can be charged.

Vacant Unit Rule

Owners certify that if a low-income unit in the project became vacant during the year, reasonable attempts were or are being made to rent that unit or the next available unit of comparable or smaller size to tenants having a qualifying income before any units in the project were or will be rented to tenants not having a qualifying income.

Following the vacant unit rule allows credits to continue to be claimed if an LIHTC-eligible household moves out and with a reasonable attempt to rent the unit, it stays vacant. This rule is violated if there is no marketing, the units are offline, or if the unit is rented to an ineligible household.

Next Available Unit Rule

Owners must certify that if the income of tenants of a low-income unit in the building increased above the limit allowed, the next available unit (NAU) of comparable or smaller size in the building was or will be rented to tenants having a qualifying income. This is the NAU rule and it applies whenever a household's income rises above 140 percent (or 170 percent at deep-rent skewed sites) of the tax credit program's income limits.

In general, the rule permits units occupied by households whose income exceeds 140 percent of the maximum allowable income (or 170 percent of deep-rent skewed limits) to remain eligible for tax credit purposes, but only if you rent the next available market-rate or rent-restricted unit of comparable or smaller size in the same building to a qualified, low-income applicant [IRC §42(g)(2)(D)]. Thus, leasing agents need to know if there are any over-income households in the building before renting a vacant unit.

Extended Use Agreement

Owners certify that an extended use commitment was in effect. This commitment is also referred to as the extended use agreement or land use restriction agreement (LURA). This is a contract between the owner and the state housing agency. It spells out the requirements for compliance during the extended use period, which applies to buildings placed in service after 1989. The extended use period continues after the 15-year compliance period and lasts an additional 15 years or longer.

The purpose of the extended use agreement is to commit owners to maintaining low-income units at their site even after the compliance period has ended and they’ve claimed all their tax credits. Although owners can’t lose credits during the extended use period, state housing agencies can sue owners for breach of contract if management fails to follow the provisions of this agreement. According to the IRS, extended use agreements must:

• Specify that the applicable fraction for the building for each year in the extended use period won’t be less than the applicable fraction specified in the extended use agreement;
• Prohibit the eviction or the termination of tenancy (other than for good cause) of an existing tenant of any low-income unit, or any increase in the gross rent with respect to such unit not otherwise permitted under tax credit regulations;
• Allow individuals (whether prospective, present, or former occupants) who meet the LIHTC income limitations the right to enforce in state court the maintenance of the applicable fraction and the prohibition against the eviction or the termination of tenancy (other than for good cause) of an existing tenant of any low-income unit, or any increase in the gross rent with respect to such unit not otherwise permitted under tax credit regulations;
• Prohibit the disposition to any person of any portion of the building unless all of the building is disposed of to that person;
• Prohibit the refusal to lease to Section 8 voucher holders because of the status of the prospective tenant as such a holder; and
• Provide that the agreement is binding on all successors of the owner.

Non-Transient Basis

The owner must certify that all low-income units in the project were used on a non-transient basis, unless an exception such as transitional housing for the homeless provided under Section 42(i)(3)(B)(iii) or single-room-occupancy units rented on a month-by-month basis under Section 42(i)(3)(B)(iv) applies. This requirement prevents tax credit sites from being used for short-term housing, and this includes renting a unit on a month-to month basis.

The transient unit rule has exceptions for specific types of homeless shelters and single-room occupancy units (SROs). But generally speaking, the IRS will presume that a rental isn’t transient if the household commits to an initial lease term of at least six months.

Findings of Noncompliance

Even though the certification is made to the state agency, failure to complete the annual certification is reportable to the IRS on Form 8823, Low-Income Housing Credit Agencies’ Report of Noncompliance or Building Disposition, line 11d. Some of the common problems reported to the IRS are:

• The certification is incomplete. The owner didn’t certify compliance with a specific IRC Section 42 requirement.
• The certification isn’t signed, which means there is not a “certification.”
• For nonresponsive owners, usually after sending reminders to the owner, the state agency will report that the certification hasn’t been received.

The IRS views the annual certification, even if self-prepared, as credible evidence of compliance with specific IRC Section 42 requirements. If the site is audited, the certification can eliminate significantly detailed analysis of an owner’s records. But in a case in which an owner didn’t make the certification, the owner may be able to show compliance with the 12 requirements with documentation.

The problem is that after-the-fact documentation is often incomplete and lacks credibility. In some cases, it may be impossible to provide satisfying evidence of compliance.

For example, as part of the annual certifications, owners certify that the project was suitable for occupancy. In the absence of the self-certification, an auditor may ask if the site was inspected by the state agency as part of its compliance monitoring responsibilities, which would provide very credible evidence. But if the state agency didn’t inspect the site, then there would be nothing contemporaneously prepared to show that the project was suitable for occupancy.

A failure to certify raises questions about the owner’s ongoing compliance with the requirements for operating the IRC Section 42 site. As a result, an auditor may be likely to consider expanding the audit to include a more in-depth analysis.