How to Maintain Tax Credit Compliance at Deep Rent-Skewed Sites

Deep rent-skewing is an attractive option for sites in cities where market-rate rents are high. If you manage or are about to manage a site in such a city, your site’s owner may have decided that it was more economically feasible to make your site “deep rent-skewed.” The owner may have decided to obtain this designation to garner support needed to finance and build the site, or the owner may have wanted to develop a mixed-income site with market-rate units equipped with high rent-garnering amenities. Deep rent-skewed sites don’t have to make market-rate units available if a low-income household goes over-income. In exchange for these benefits, owners must meet even tougher income restrictions for low-income units than the site’s minimum set-aside requires.

If your site is deep rent-skewed, you need to know three key compliance differences. Deep rent-skewing affects how you qualify your site; how much rent you charge; and how you comply with the next available unit (NAU) rule. We’ll tell you how to determine if your site’s owner elected to deep rent-skew the site and what you need to know about each of these differences so you can keep the owner’s tax credits safe.

Determine if Owner Chose Deep Rent-Skew Option

If you are about to manage a new tax credit site, check IRS Form 8609, which the site owner is required to file to obtain a housing credit allocation from the housing credit agency. On line 10c, the owner elects the minimum set-aside for the site. And on line 10d, the owner elects to deep rent skew at the same site.

If the box labeled “15-40” is checked on line 10d, then the owner made this election. This label refers to the deep rent-skewing set-aside. If this box isn’t checked, then your site isn’t deep rent-skewed. Only if the owner elects to deep rent skew on line 10d are the low-income units fixed or market-rate units exclusive to market-rate tenants.

Deep Rent-Skewing Affects Three Compliance Activities

Here’s an overview of the three ways deep rent-skewing affects what you must do to maintain compliance with the tax credit program:

1. Minimum set-asides. Generally, an owner must comply with the site’s minimum set-aside to be part of the tax credit program. In other words, you must rent a certain number of units to households earning no more than a certain percentage of area median income (AMI). For example, if your minimum set-aside is “20-50,” you must rent at least 20 percent of your units to households earning 50 percent or less of AMI. And if your minimum set-aside is “40-60,” you must rent at least 40 percent of your units to household earning 60 percent or less of AMI. These units become the site’s qualified low-income units.

For deep rent-skewed sites, an owner commits to one of the two minimum set-asides and to an additional deep rent-skewed “15-40” set-aside. This means you must rent 15 percent of all your low-income units to households earning 40 percent or less of AMI. This level of AMI is referred to as extremely low income. For example, suppose you manage a 60-unit building and your minimum set-aside is “20-50.” This means you must rent 12 units (20 percent of 60 units) to qualified low-income households. With the deep rent-skew, you have to rent two of the low-income units (15 percent of 12 units) to households earning 40 percent or less of AMI.

The deadline for meeting the deep rent-skewing set-aside is the same as the deadline for meeting the minimum set-aside. It’s the end of either the placed-in-service year or the following year, depending on what the owner elected on its Form 8609. If you meet the minimum set-aside but not the deep rent-skewing set-aside, your site won’t qualify as deep rent-skewed. If you meet the deep rent-skewing set-aside on time, but you don’t maintain the set-aside during later years of the compliance period, your site will lose its deep rent-skewed status for those years.

2. Rent limitations. For a tax credit unit to be in compliance, the rent must be restricted. The rent depends on current income levels in effect. When an owner agrees to deep rent skew, it commits to renting 15 percent of its tax credit units to households who qualify with an annual income of no more than 40 percent of AMI. Since a household must qualify at 40 percent of the AMI to live in a deep rent skew unit, calculate its maximum rent using 40 percent of AMI for its assumed household size.

For the remaining tax credit units, you would calculate the maximum rent using the applicable income limit. For example, if a resident must qualify at 60 percent of AMI, calculate the maximum rent using 60 percent of AMI for the assumed household size. And if a resident must qualify at 50 percent of AMI, calculate the maximum rent using 50 percent of AMI for the assumed household size.

Many deep rent-skewed sites include both tax credit and market-rent units. If this applies to your site, it’s important to note that the average rent charged for the market-rent units must be at least double the average rent charged for the tax credit units of the same unit size [IRC §142(d)(4)(B)(iii)]. This means that if the maximum allowable rent exceeds one-half of the average gross rent of comparable market-rate units, you’ll have to charge less than the maximum.

For example, suppose a mixed-income site has 100 two-bedroom units. The owner elected to have a “20-50” minimum set-aside with a deep rent-skew. Because of the minimum set-aside, the site contains 20 tax credit units and 80 market units. If the two-bedroom tax credit rent is $1,000, the owner must charge at least $2,000 for the market units to collect the $1,000 tax credit rent. However, if the demand in your area will bear only $1,800 for market units, you can only charge $900 in rent for two-bedroom tax credit units.

3. Next available unit rule. If a low-income household goes over-income, you must comply with the NAU rule. For a site that’s not deep rent-skewed, if the income of a low-income household increases above 140 percent of the income limit, the credit is still available as long as the next available same or smaller size unit (even if a market-rate unit) is rented to an eligible low-income household, so that the site’s applicable fraction will produce the anticipated tax credit without including the unit occupied by the over-income household. But if your site is deep rent-skewed, you should be aware that the NAU rule is different in four key ways.

> Limited to low-income units. At a deep rent-skewed site, you have to rent only the next available low-income unit to a qualified low-income household. The market units are fixed, and you’re allowed to continue renting your market-rate units to market-rate households, generating more site revenue.

> Comparable size or smaller than the over-income unit not required. At a site that’s not deep rent-skewed, the next available unit you rent to a qualified low-income household must be of comparable size or smaller than the unit in which the over-income household lives. But at a deep rent-skewed site, the next available unit can be larger.

> Higher over-income threshold. For deep rent-skewed sites, 170 percent of their current income limit is the threshold for when a low-income household is considered over-income. The 170 percent threshold applies to all your low-income households, not just the 15 percent that are deep rent-skewed.

> NAU households must earn 40 percent or less of AMI. If an owner finds that any low-income household is over-income, the owner must rent the next available low-income unit to a resident with income not exceeding 40 percent of the AMI.

And as long as any low-income resident remains above 170 percent of his current income limit, the owner must rent all available tax credit units to deep rent-skew residents. In other words, you must always rent the next available unit to a household earning no more than 40 percent of AMI, even if the over-income household was living in your regular tax-credit unit and not in one of your deep rent-skewed units. As a result, the owner may need to deep rent skew more tax credit units than originally planned over time. However, the owner enjoys not being forced to rent a market unit to a low-income resident when a low-income resident becomes an over-income resident.