Ahead of the Curve: Preparing a Tax Credit Property for an HFA or Investor Review

By A. J. Johnson
October 6, 2013 8 min read

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Every low-income housing tax credit (LIHTC) property is subject to periodic site inspections and reviews by various parties seeking to determine whether the project is in compliance with the requirements of the federal tax credit program and the state credit agency. These parties include state housing finance agencies (HFAs), which must visit and review each LIHTC project at least once every three years; management companies responsible for compliance; owner or investor representatives; and possibly the Internal Revenue Service.

Because reviews by HFAs and investors (or investor representatives) are arguably the most critical, let’s look at the key areas that these reviewers will generally examine and recommend steps for management to undertake prior to a review.

Step 1: Address Rent Issues

Maximum rents for housing credit units are calculated using the current annual household income limits published by the U.S. Department of Housing and Urban Development (HUD) for the metropolitan area, city, or county in which the project is located. Staff should therefore ensure that they are using the correct set of HUD income limits when determining the maximum income for households to qualify as low-income, and in calculating maximum LIHTC unit rents. The possible set of incomes limits are the regular Multifamily Tax Subsidy Projects limits, the HERA special limits, or national nonmetropolitan income limits.

HUD publishes updated income limits annually, usually around December 1. When the income limits are updated the maximum allowable tax credit rent may also change. Therefore the management company must verify that the rents charged to low-income residents do not exceed the statutorily allowable rent. When examining rent levels:

1. Make sure that the lease rents do not exceed the maximum rent allowed by the LIHTC program;
2. Ensure that the utility allowance amount for each type of unit is up to date and is included in the unit’s gross rent. Utility allowances should be updated annually, and a copy of the source documents for each allowance kept on site;
3. Watch out for any optional fees. If residents pay any fees in addition to rent, such as washer/dryer rentals or pet fees, make sure that these are clearly optional to residents and are documented separately from the unit rent. Keep a list of all optional fees that a reviewer can look at. Be able to demonstrate that the fees are optional to the resident if they would cause the resident’s total out of pocket payment to exceed the maximum allowable monthly rent; and,
4. Check the property’s Extended Use Agreement for any special rents that must be charged that may differ from the rents required by the LIHTC program. For example, even though selecting the 40/60 minimum set-aside test for the project, the owner may have promised to set rents based on the 50% income limits in order to obtain a higher score on the LIHTC application.

Step 2: Review Initial Resident Files

Ideally management should review all of the initial resident files before a site review. If not, management should at least make sure these files are available for inspection by a reviewer and that each LIHTC unit resident file contains an income certification, a lease, and verifications of household income.

The HFA will review the original resident files during its review of a property, to determine if the initial applicable fraction was met or if the minimum set-aside was met by the statutory deadline. An investor may also conduct this kind of a review at any time during the tax credit compliance period. After its initial review, the HFA is not likely to request the original resident files again, but they should always be kept readily available.

Step 3: Review Current Resident Files

Management should make sure that there is a current file for each LIHTC unit resident containing a current lease, tenant income certification, and verifications. This documentation should be adequate to show that the household is clearly eligible. If the current certification shows the household to be above the income limits in place, staff should ensure that the move-in certification clearly demonstrates eligibility.

In reviewing files, pay close attention to documentation regarding student status, especially if there is significant local student population. Staff should look closely at households that have a “student appearance” (e.g., comprised solely of young roommates with limited income). When in doubt, it is not unreasonable for management to request information from local colleges and universities.

If a unit’s occupancy does not appear reasonable, the file should provide an explanation. An example might be one person in a three-bedroom unit. This person might have a child that visits in the summer or needs lots of room for storage.

Similarly, provide documentation if the tenant income and rent are out of proportion, such as a person with a monthly income of $600 and rent of $650. Perhaps this resident has adequate assets to pay the rent through the lease term.

The pre-audit review process should be relatively simple and quick. Staff should look for any patterns of documentary weakness in the files, such as certified income and assets not supported by independent verifications. If a household’s assets are $5,000 or less, make sure that the household members have provided an affidavit that states their assets are $5,000 or less and discloses any income from those assets.

Step 4: Check Leases

Every file should contain an executed lease that is at least six months long. The lease should contain LIHTC appropriate clauses relating to student status, recertification requirements, and rules relating to notification of changes in household composition.

Step 5: Review Filed Rental Applications

Make sure all rental applications have been filled out completely. Many reviewers will take the position that blank sections mean that important information may have been left out.

Similarly, determine that the application and other documentation in the file do not contradict one another. An example might be if an applicant states an annual income of $40,000 on the application, which in this case would put them over the applicable LIHTC income limit, but the employment verification comes back stating an income of $30,000, which is within the income limit. Clarifications of discrepancy should be inserted in the file.

Step 6: Review Other Set-Asides and Requirements

Management should also:

• Review the original tax credit application and Extended Use Agreement for the property. The developer may have made significant promises to the HFA in exchange for receiving tax credits, such as a special set-aside or lower rents. These additional requirements should be outlined in the project documents.
• Ensure that the characteristics of the property match the elections made on IRS Form 8609. Review the minimum set-aside election, deep rent skewing election, and the required applicable fraction.
• Check employee or set-aside units. If there are any employees living on site who are not qualified low-income residents, make sure the HFA approved them living in those set-aside units and the particular size unit they occupy.

Step 7: Inspect the Property for Habitability Issues

HFAs file Form 8823 with the IRS to report incidents of noncompliance at a property with LIHTC program requirements. Filed 8823s relating to habitability can trigger an IRS audit.

Before an HFA or investor review, management should make a thorough physical inspection of the property. This should cover building exteriors, grounds, common areas (lobby, office, community rooms, storage areas, trash collection areas, laundry rooms, stairwells, halls, public restrooms, etc.), and the interior of every residential unit (both vacant and occupied). An HFA must inspect at least 20% of a property’s units, but there is no way of knowing which units these will be or how many. Accordingly management should pre-inspect every unit if they have time before a review, but at a minimum as many units as possible within the time constraints. The odds for a successful inspection can be greatly improved by:

• Trimming plantings;
• Picking up site litter;
• Removing graffiti;
• Replacing burned out bulbs;
• Replacing broken switch plates and outlets;
• Repairing leaky faucets and clogged toilets;
• Fixing any broken door or window locks; and,
• Making sure all smoke detectors are working

Step 8: Correct All 8823s Expeditiously

If any 8823s are outstanding for the property, correct the noncompliance as soon as possible. Nothing is as important to a property’s ability to claim all credits as ensuring that any previous noncompliance has been corrected. This not only meets the legislative intent of the LIHTC program but also shows HFA reviewers that their findings are being addressed. This puts them in a much better frame of mind when they next review the property.

The previous recommended steps for preparing for a site review should be institutionalized by management as an ongoing process. If staff is doing a good job of tax credit management daily, additional preparation will be minimal, and all reviews and audits should go smoothly.

A. J. Johnson is president of A. J. Johnson Consulting Services, Inc., a Williamsburg, Va.-based full service real estate consulting firm specializing in due diligence and asset management issues, with an emphasis on low-income housing tax credit properties. He may be reached at 757-259-9920, [email protected].