How to Control Business Use of Tax Credit Units

According to U.S. Census data released in June 2011, more than half—51.6 percent—of all the country's businesses that responded to the 2007 Survey of Business Owners were operated primarily within homes or other noncommercial spaces. And because the data was compiled before the recession began in 2008, it may be safe to assume that there has been a sharp increase in home-based businesses since then.

At your site, you may have a few residents, frustrated with not finding employment, who are considering starting a home-based business. While some site owners may be reluctant to permit households to run businesses in their units, allowing some types of home-based businesses may help you to keep qualified households. We'll cover the pros and cons of allowing home-based businesses at your site.

If you choose to disallow home-based businesses at your site, we'll give you a Model Lease Clause that you can adapt for that purpose. If you're going to allow home-based businesses, you'll need to come up with some guidelines about what your residents can and can't do when it comes to working from their homes. Otherwise, you could end up with insurance problems and legal troubles. We'll give you a Model Policy: Create Reasonable Guidelines for Business Use of Units, and a Model Form: Have Residents Fill Out Application Before Using Unit for Business Purpose, that you can adapt and use at your site.

Problems with Resident Businesses

Residents who use their units to operate a business can cause all kinds of troubles for your site. For example, businesses like day-care centers, catering and food preparation operations, and professionals who see clients in person—such as attorneys, accountants, or therapists—have the potential to:

• Congest parking areas and increase traffic;

• Necessitate frequent deliveries;

• Cause noise, odors, and pests where food preparation is involved;

• Create fire hazards;

• Overuse water and other utilities that the owner may have to pay for;

• Disproportionately fill Dumpsters;

• Violate zoning laws;

• Increase the site's security risks from strangers coming and going through hallways;

• Cause greater wear and tear on the unit; and

• Increase insurance premiums or claims, in some cases.

Residents' businesses can also create “liability nightmares,” according to Ohio real estate attorney James Bownas. “If the residents' customers are on the premises, they're considered ‘business invitees’ and you're responsible for their safety,” he says. In case you're thinking of gray suits and briefcases, you should realize that “business invitees,” can include children attending a resident's day-care center.

Finally, owners can lose their insurance coverage if residents operate businesses in their units. Most insurance policies—both property and liability—require that the premises be used only for residential purposes, Bownas explains. As a result, the insurer won't pay for losses attributable to fires, explosions, and other accidents resulting from residents' business activity. For example, if a unit used as a bakery catches fire, your insurance may not cover the loss.

Limiting Home-Business Use

A few years ago, it wasn't clear that residents at tax credit sites were permitted to have home-based businesses. The Tax Reform Act of 1986 requires any portion of a site used for nonresidential or “commercial” purposes to be excluded from the eligible basis on which the owner's credits are calculated. But in 2009, the IRS released a revision to the “Guide for Completing Form 8823 Low-Income Housing Credit Agencies Report of Noncompliance or Building Disposition,” which stated that the IRS allows home-based businesses as long as the unit is used primarily as a residence. According to the guide, a resident may indeed use a portion of her unit for a home-based business and may even claim the associated expenses as a business deduction on her tax return on Schedule C and Form 8829 as long as the unit is her primary residence.

Although the IRS permits home businesses, this doesn't mean the owner or manager has no discretion as to whether they're allowed on the site. “We try to view the IRS provisions allowing home businesses as pertaining to tax credit permissibility and not as a blanket authority. For example, IRS provisions would permit a charge for a pet, but don't require that you allow pets,” explains Michael Kotin of Kay-Kay Realty, a tax credit management and consulting firm.

Resident safety and premises liability are the primary reasons that Kotin has historically tried to ban business activity from residential communities. “Our criterion is traffic—any business activity that requires traffic to the unit or property is prohibited. The primary reason is to deter illegal drug sales. Traffic is the most common indicator of a drug unit. And by banning all excessive short-term traffic, we avoid the need to prove drugs are involved and can act solely on the traffic,” says Kotin. “Businesses that can fly below the radar are not a problem,” he adds. An example of this might be an outside sales consultant who “works from home.” The household may have a two-bedroom unit and have made the second bedroom into an office. They don't have traffic and don't disturb the neighbors.

Use Lease Clause to Strictly Limit Home Business

After considering all the problems home-based businesses may cause your site and the additional work there may be to ensure home businesses follow the guidelines you set, you may feel that allowing home businesses isn't worth the trouble. If this is the case, you should include in the lease a specific ban on resident businesses.

Our Model Lease Clause below takes a two-pronged approach. First, it requires residents to use their units “strictly for residential purposes.” Owners often assume that this goes without saying. But this may not always be the case. Considering how common it has become to do business from home, residents might take for granted that they can operate a business in the unit.

In addition, to make sure the message is clear, the Model Lease Clause also bans business or professional use of the unit and gives specific examples. The list of examples focuses on business uses where outsiders come into the unit to do business with the resident—such as running a day-care center or seeing clients or patients in the unit.

To make sure your clause complies with any state laws on permissible uses, show this Model Lease Clause to your attorney before using it in your leases.

Model Lease Clause

Use of Premises. Resident shall occupy and use the premises as a private residence and for no other purpose. Resident shall not carry on any trade, profession, business, school, course of instruction, or entertainment on the premises. This includes but is not limited to: keeping roomers, lodgers, or boarders; operating a day-care center; consulting or examining clients or patients; selling, reselling, or trading goods; grooming or training animals; teaching an instrument, vocal music, dramatics, or dancing; performing or speaking for audiences; and operating a baking, catering, or other food service business. Failure to comply with this provision is a substantial violation of the lease and may result in Resident's eviction from the unit.

“You should be careful to check any state laws that might apply when considering a ban of resident businesses,” says tax credit consultant Elizabeth Moreland. In California, for example, it's illegal for owners to prohibit residents from operating licensed day-care centers out of their units. This is also the case in New York State. New York courts have interpreted a social services law forbidding local governments from zoning or otherwise banning child care in neighborhoods as overriding public policy, which means it trumps an owner's right to evict a tenant for operating a business in the unit. The New York courts view providing child care as consistent with residential use. Therefore, neither owners nor government bodies can lawfully prohibit it.

If you live in a state that forbids banning licensed day-care centers in units, the best plan for an owner in this situation is to work with the resident to ensure a safe environment for the children and to reduce liability risks. You can ask the resident to add you to her liability insurance policy as an “additional insured,” so you can get the same kind of protection for any added liability from the day-care operations.

Set Safeguards When Allowing Home Businesses

You may wish to be more lenient when considering allowing home-based businesses at your site, especially if many residents have lost their jobs and are pressuring you to allow them to start their own businesses. For these people, their homes are the most convenient and cost-effective workplace, and allowing them to work there may help you to keep them as qualified households.

Require resident to submit application form. “If an owner decides to allow certain business, the manager should create an approval process that the resident must go through to ensure the owner is protected as much as possible,” says Moreland. By funneling all the resident's interests in starting a business through an application process, the owner can ensure that the business is compatible with the household's living environment and won't interfere with other households' use or enjoyment of their units, or be illegal.

“Some zoning ordinances will preclude businesses right from the get-go, and owners must know what is allowable and what isn't to ensure they don't violate these ordinances,” adds Moreland. For example, a county may prohibit auto repair, auto cleaning, and sales of alcoholic beverages out of a resident's home. Any businesses discovered that didn't get the owner's written approval should be grounds for eviction, she adds.

For an example of an application form you can adapt to determine whether a resident's proposed business use of her unit is appropriate for your site, see our Model Form: Require Owner Approval Before Using Unit for Business Purposes.

Develop specific rules governing business use of units. You should create rules on what residents may and may not do if they have home offices or businesses in their units. You can adapt our Model Policy: Create Reasonable Guidelines for Business Use of Units for use at your site. You can incorporate these rules into your lease in the form of a lease addendum or add them to your site rules, says Atlanta attorney Robin Hein. You should give these rules to all residents upon move-in and lease renewal.

If your rules are reasonable and well thought out, you'll be able to protect the residential nature of your site while giving residents the flexibility of using their units for business purposes. And with a set of written rules, you'll be able to enforce them against a resident who violates them. Your rules should include the following restrictions on residents' businesses:

• Ban all illegal businesses. Although your lease probably already bans illegal activity in units, say in your rules that residents can't conduct any illegal business, such as the sale or manufacture of drugs or the sale of guns, out of their units. If applicable, refer to the section of your lease that bans illegal activity.

• Ban any business use inconsistent with residential nature of site. You don't want residents' business use to change the residential nature of your site. Even though your rules will go on to ban specific actions, set this general rule in case something comes up that you didn't foresee.

• Ban any business for which resident hasn't gotten necessary government approvals. Some businesses require licenses, approvals, zoning variances, or other documentation from the local, state, or federal government before they're considered legal. So say that anyone who plans to run a business at your site must get the proper government approvals.

• Ban any business that puts undue burden on common areas. You don't want a resident's business to create an undue burden on your common areas. For example, you don't want a resident to set up a home business that will create an excessive amount of foot traffic in the hallway. You have an obligation to all your residents to give them an equal opportunity to enjoy the common areas. Any business use that would interfere with that shouldn't be allowed.

• Ban any business that creates nuisances to neighbors. Ban any business that creates nuisances, such as noise, vibrations, glares, fumes, odors, or electrical or electronic interference, detectable by neighbors.

• Ban displays or signs. To maintain the residential nature of your site, don't let residents put up business signs.

• Ban any business that would generate significant traffic. Increased traffic—whether it's car, truck, or foot traffic—will have a negative effect on residential life. In particular, it can compromise security and increase the chance of crime. So ban any business that would increase traffic or put a strain on your site's parking.

• Ban storage of equipment outside unit. Storage of equipment outside the resident's unit will affect the residential nature of your site and could cause a trip-and-fall hazard. So ban residents from doing so.

• Ban on-site employees, except family members who reside in the unit. To maintain the residential nature of your site and to avoid a strain on parking, and increased traffic, don't allow any business that has on-site employees, other than family members who reside in the unit.

• Ban any business that involves use, storage, or disposal of any hazardous materials. It stands to reason that you don't want to invite dangerous materials onto your site. So ban any home business that involves the use, storage, or disposal of hazardous materials.

• Require home business use to be subordinate to unit's residential use. This means requiring the resident to use the unit primarily as a home. Also, ban any external modifications in the unit and require the resident to get prior consent from management for any modifications, external or internal, he wants to make.

Insider Sources

James H. Bownas, Esq.: Zaino and Humphrey LPA, 5775 Perimeter Dr., Ste. 275, Dublin, OH 43017; www.zandhlpa.com.

Robin Hein, Esq.: Attorney at Law, Fowler, Hein, Cheatwood and Williams, P.A., 2970 Clairmont Rd., Ste. 220, Atlanta, GA 30329; www.apartmentlaw.com.

Michael Kotin, HCCP: Principal, Kay-Kay Realty Corp., 6908 E. Thomas, Ste. 300, Scottsdale, AZ 85251; www.kaykayrealty.com.

Elizabeth L. Moreland, NCP-E: President, Elizabeth Moreland Consulting, Inc., 6907 University Ave., Ste. 196, Middleton, WI 53562; www.taxcredit.com.

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