First-Year Compliance Issues: Back to Basics, Part I

Published by Stephanie Naquin on Friday, May 4, 2018
Journal cover thumb May 2018

Some key concepts related to the first year of the low-income housing tax credit (LIHTC) compliance period are commonly misunderstood. 

Because the first year can make or break a project, it’s paramount to discuss the fundamentals! Part I of this column will discuss compliance timelines and the minimum set-aside requirements. Part II will appear in the June Novogradac Journal of Tax Credits and will compare general credit calculations and first-year credit calculations. 

Timelines: 

Terms like credit period, compliance period and extended-use period are commonly used without truly understanding what each one means. The credit period, or tax credit period, is Years 1-10. This is the time frame in which a credit is generally claimed against a taxpayer’s federal income tax. The benefit of this tax credit is that it provides a dollar-for-dollar reduction in a taxpayer’s federal income tax; whereas, a tax deduction only provides a reduction in taxable income. The compliance period is Years 1-15 and represents the total period over which noncompliance could result in disallowance or recapture of credits. It is during this period that the allocating agency reports noncompliance to the Internal Revenue Service (IRS) on Form 8823. For any allocation of credit under Internal Revenue Code (IRC) Section 42 made in/after 1990, there is a minimum 30-year extended use period. The trick to all of these different timelines is that they commence Jan. 1 of the first year of the credit period and the election of when that begins is made on Line 10a in Part II of IRS Form 8609. 

An owner can choose to start the credit period the year the building is placed in service (this date is found on Line 5 in Part I of IRS Form 8609) or defer to the next calendar year. The election is made on a building-by-building basis. For example, if the building is placed in service June 15, 2017, the owner can elect to start the credit period in 2017 by selecting “No” on Line 10a in Part II of IRS Form 8609. In that case, the start date of the first year of the credit period is Jan. 1, 2017. Or, the owner could defer to start the credit period to 2018 by selecting yes on Line 10a in Part II of IRS Form 8609, in which case the start date of the first year of the credit period is Jan. 1, 2018.  The credit period, compliance period and extended-use period will all have the same start date but when each term ends varies. 
 
With all first year compliance concepts, it is important to remember that the reference to “Year 1” or the “first year” is descriptive of the first year of the credit period, compliance period and extended-use period. 

Journal May 2018 Property Compliance graph

Minimum Set-Aside

Q: What minimum requirements must be met in order for a project to be considered a qualified rental project under IRC  Section 42(g)(1)? 

A: To be considered a residential rental project, the minimum set-aside must be met by Dec. 31 of the first year. The minimum set-aside is an election made on Line 10c in Part II of IRS Form 8609.  In general, compliance professionals refer to the 20-50 or 40-60 elections. The minimum set-aside represents the minimum number of units that have to be occupied at that limit. Meaning, if the 20-50 minimum set-aside were elected, then 20 percent of the units in the project must be occupied by households that have an income at/below 50 percent area median income (AMI) adjusted for household size and a gross rent at/below the 50 percent rent limit for the bedroom size. Conversely, if the 40-60 minimum set-aside was elected, then 40 percent of the units in the project must be occupied by households that have an income at/below 60 percent AMI adjusted for household size and a gross rent at/below the 60 percent rent limit for the bedroom size. If the minimum number of low-income units is not achieved by Dec. 31 of the first year of the credit period, then the project is not a qualified residential rental project and no credit can be claimed. This is a unit count completed on a project  basis. There is a new election called income averaging that starts this year for properties that have not elected their set-aside yet. Income averaging would allow for an average of 60 percent AMI and up to 80 percent AMI. See “Implementation of LIHTC Income Averaging” at www.novoco.com/blog. 

Minimum Set-Aside Project-Wide Test

Q: Is the minimum set-aside test on a building-by-building basis or project-wide basis?

A: The minimum set-aside test is on a project-wide basis. As mentioned, the minimum set-aside election is on a building-by-building basis, but the minimum set-aside is based on a project-wide basis, meaning that buildings are aggregated for the test. For example, if two buildings are each 10 units, and each elected the 40/60 set-aside, and Building A has three LIHTC qualified units on Dec. 31, and Building B has five LIHTC qualified units on Dec. 31, then they can be aggregated for the test. Although Building A fails the set-aside test on a stand-alone basis, it can rely on Building B, so that they pass the minimum set-aside test in the aggregate. 

Because the first-year credit period election is made on a building-by-building basis, and because buildings might place in service in different years, there could be two properties for purposes of the minimum set-aside. For example, for a given 15-building development, you could identify one 10-building project for buildings in service in a particular year and a separate five-building project for buildings in service in a later year. 

IRS Form 8609- Question 8b

Q: How are buildings identified and grouped together as a project?
A: The election to treat the buildings as part of a multiple building project for purposes of IRC §42, appears on the Form 8609, Line 8(b). As a general rule, owners of low-income buildings should answer the multiple building 8(b) question "Yes." If answered yes, then a statement is attached to the 8609s that identifies the buildings and year in service and grouped by year based on the placed in service date or first year credit election. All the buildings must satisfy the minimum set-aside test on a project basis. As such, the proper attachments are critical. 

Part II of this column will be published in the June issue of the Novogradac Journal of Tax Credits and will address general credit calculations and first-year credit calculations.