Perform 8 Compliance Checks on Available Units Before Offering a Lease

Before you rent any unit at your tax credit site to a new household, it’s important to confirm that the rental will comply with the tax credit law. If your rental of a unit won’t comply, the owner’s credits for that unit may be at risk. And if the unit is one you must count to meet or maintain your site’s minimum set-aside, that one noncomplying unit may place all the owner’s credits in jeopardy.

Before you offer a lease for a low-income or market-rate unit, you should conduct eight compliance checks to confirm that the proposed rental will meet the requirements for compliance. The first three compliance checks below apply to all units at a tax credit site whether they’re low-income or market-rate. And the remaining five checks apply only to low-income units. Therefore, if you manage a 100-percent building, a building with no market-rate units, you must pass all eight compliance checks before renting any unit at your site. But if you manage a mixed-income building, you’ll need to pass only the first three checks before renting your market-rate units.

ALL UNITS

Before you rent any unit, low-income or market rate, at your site to a new household, make sure to consider whether the unit passes the following requirements.

[] Suitable for Occupancy

A unit must be continuously suitable for occupancy in accordance with state or local codes in order for credits to be claimed. This means that, at the least, you must fix local code violations relating to the unit. For instance, you may need to repair or replace faulty smoke detectors or sprinklers in the unit, clear the unit of pest infestation, or fix electrical, heating, or plumbing problems in the unit. You should also review your state housing agency’s standards for inspecting units to learn what else you may need to do to keep the unit suitable for occupancy.

It’s important to note that, in addition to state agency inspections, the IRS makes sure you are complying with the suitable for occupancy requirement through your site’s annual certification to your state agency. Under Treasury Regulation 1.42-5(c)(1)(vi), an owner must certify annually to the state agency that, for the preceding 12-month period, the site was operated in compliance with Internal Revenue Code Section 42 requirements. And as part of the certification, the owner must disclose whether the buildings and low-income units at the site were suitable for occupancy, taking into account local health, safety, and building codes (or other habitability standards).

In addition, the owner must disclose whether the state or local government unit responsible for making local health, safety, or building code inspections issued a violation report for any building or low-income unit for the site. 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 state agency and explain whether the violation has been corrected.

[] General Public Use

All residential rental units at a LIHTC site must be available for use by the general public. LIHTC sites are subject to the Fair Housing Act, which prohibits discrimination in the sale, rental, and financing of dwellings based on race, color, religion, sex, national origin, familial status, and disability.

Make sure your leasing agents understand that federal fair housing law makes it illegal to reject prospects on the basis of race, color, gender, religion, disability, national origin, or familial status. Your state or city may also ban discrimination based on other factors, such as age, creed, or source of income. Finally, your leasing agents must be aware that the tax credit law bars you from turning away prospects because they hold Section 8 vouchers or certificates.

You should know that in some cases, the IRS has outlined acceptable tenant preferences. Internal Revenue Code (IRC) §42(g)(9) clarifies the application of the public use requirement to certain groups. It states that a project does not fail to meet the general public use requirement solely because of occupancy restrictions or preferences that favor tenants (a) with special needs; (b) who are members of a specified group under a federal or state program or policy that supports housing for such a specified group; or (c) who are involved in artistic or literary activities. IRS Revenue Procedure 2019-17 notes that certain federal or state programs support housing for military veterans.

[] Residential Purposes

Your units must be used primarily for residential purposes. This means you must rent your market-rate units only to individuals and not to companies. It’s okay to have commercial space at your tax credit site. But your units are included in your site’s eligible basis, which means they must be kept residential.

You may let residents conduct some business in their units. But if a household doesn’t keep its unit primarily residential, the unit won’t be in compliance.

In addition to units being a part of your site’s eligible basis, you should be aware that common areas are considered residential rental property if functionally related to the LIHTC building or LIHTC site. Under IRC §42(d)(4)(A) and §42(d)(4)(B), the eligible basis for a qualified LIHTC building or a qualified LIHTC project includes the adjusted basis of the property used in common areas or provided as comparable amenities to all residential rental units in the building. Typical common area noncompliance may involve converting common areas to commercial property, charging fees for facilities (such as a swimming pool), or habitability and health/safety violations.

LOW-INCOME UNITS

Here are additional compliance checks you should perform before renting any low-income unit at your tax credit site to a new household:

[] Certify Household’s Income

Before you rent a unit to a low-income household, you must certify and verify the household’s income. Even though HUD doesn’t administer the tax credit program, the tax credit law requires owners and managers to use the HUD rules for calculating household income at a tax credit site. These rules can be found in Section 4350.3 of the HUD Occupancy Handbook (“Occupancy Requirements of Subsidized Multifamily Housing Programs”). It details whose income you must count and how you must calculate income. If you rent the low-income unit to a household and you operate a mixed-income site, keep in mind that you’ll also need to recertify the household’s income for the low-income unit on an annual basis.

[] Calculate Maximum Allowable Rent for Unit

Under the tax credit law, you can’t charge more than the “maximum allowable rent”—which is based on 30 percent of area median gross income—for your low-income units. If you charge more, the unit will be out of compliance.

Area Median Income is calculated by HUD each year and varies by locality. An owner calculates the maximum allowable rent for each unit size using the site’s income limits. Maximum gross rents are limited based on a presumed household size of 1.5 occupants per bedroom, or one occupant for studio units. Therefore, studio rents are based on the AMI of a one-person household; one-bedroom rents are based upon the AMI of a 1.5-person household (the average AMI of one- and two-person households); and two-bedroom rents are based upon the AMI of a three-person household.

Remember that the rents you’ve calculated are the highest amount you can charge. So if you want to charge a whole number as your rent, you should round down. For example, if you calculate a household’s rent to be $499.99 and you want to charge a whole-dollar amount, you must round down to $499—not up to $500.

[] Factor Appropriate Utility Allowance

If residents at your tax credit site pay for their own utilities, the amount of each unit’s utility allowance affects the maximum monthly rent you can collect from the household. The utility allowance is generally based on an estimate of reasonable household consumption and cost for the unit size. As an owner or manager, failure to calculate utility allowances properly and charging gross rents that exceed the maximum rent allowed are both considered reportable noncompliance by the IRS and will result in a loss of tax credits. Therefore, be sure to get the correct utility allowance and subtract it from the household’s (gross) rent. The result is the household’s net rent, which is the amount you actually charge the household each month.

Also, the utility allowances you use must come from the right source. If your site receives assistance from a Rural Housing Service (RHS) program through Rural Development (RD), the utility allowance for all LIHTC units at your site must be determined by the method required by RD. Likewise, if an LIHTC building doesn’t receive RHS assistance but is a HUD-regulated building, the applicable HUD utility allowance is to be used for all LIHTC units in the building. However, if your site isn’t RD assisted or HUD regulated, there are four utility allowance options you may use to calculate the utility allowances. These options are your jurisdiction’s public housing authority (PHA) schedule; local utility company estimate; state housing agency estimate based on similar building/actual consumption; HUD utility schedule model; and energy consumption model.

[] Ensure Initial Lease Term Is Longer than Six Months

The tax credit law prohibits a LIHTC unit from being used on a “transient basis.” This is the reason the IRS requires a lease term of at least six months and many state credit agencies require initial lease terms of 12 months. So make sure the household will agree to sign a lease for the appropriate initial lease term. This prevents tax credit sites from being used for short-term housing and ensures that owners don’t take illegal shortcuts in meeting their site’s minimum set-aside by moving households around after a few months. The transient unit rule has exceptions for specific types of homeless shelters and single-room occupancy units.

[] Verify Student Status of Applicants

Tax credit rules bar households composed entirely of full-time students from living in a tax credit unit. To be considered a full-time student, the household member must take a full course load as defined by his or her educational institution for at least five months of the calendar year. The months don’t need to be consecutive. Children in elementary, middle, and high school are also considered full-time students.

However, a unit will still be in compliance if at least one household member is a part-time student or if one of the following exceptions to the rule applies:

• A student receives assistance under Title IV of the Social Security Act (TANF);
• A student was previously in the foster care program;
• A student is enrolled in a job training program receiving assistance under the Job Training Partnership Act or under other federal, state, or local laws;
• The household is comprised of single parents and their children, and such parents are not dependents of another individual, and such children are not dependents of another individual other than a parent of such children. In the case of a single parent with children, the legislative history explains that none of the tenants (parent or children) can be a dependent of a third party; or
• The household contains a married couple entitled to file joint tax returns.

If no exceptions apply and you move in a household that’s made up entirely of full-time students, you risk losing tax credits on the unit if your state housing agency audits the site and finds the unit out of compliance.