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Final & temporary regs and Rev Proc modify low-income housing credit monitoring rules

TD 9753, Low-Income Housing Credit Compliance-Monitoring Regulations.

PR 15034912, Notice of Proposed Rulemaking, Low-Income Housing Credit Compliance-Monitoring Regulations.

IRS has issued final and temporary regs, the text of which also serves as the text of contemporaneously issued proposed regs, relating to the compliance-monitoring duties of a State or local housing credit agency for purposes of the low-income housing credit. The regs revise and clarify the requirement to conduct physical inspections and review low-income certifications and other documentation. IRS also issued an accompanying Revenue Procedure that sets forth the minimum number of low-income units in a low-income housing project for which an agency must conduct physical inspections and low-income certification reviews.

Background. A low-income housing credit is allowed annually over a 10-year credit period beginning with the tax year a qualified low-income building is placed in service (or, if elected, the next tax year). (Code Sec. 42(f)(1)) A qualified low-income building is a building that, at all times during the “compliance period” of 15 tax years beginning with the first tax year of the credit period, is part of a “qualified low-income housing project.” (Code Sec. 42(c)(2), Code Sec. 42(i)(1) , Code Sec. 42(g))

A qualified low-income housing project is any project for residential rental property if the project meets one of the following tests, as elected by the taxpayer:

…at least 20% of the residential units are rent-restricted and occupied by individuals whose income is 50% or less of area median gross income; or
…at least 40% of the residential units in the project are rent-restricted and occupied by individuals whose income is 60% or less of area median gross income. (Code Sec. 42(g)(1))

A “low-income unit” is a residential unit that is rent-restricted and the occupants of which meet the applicable income limit elected by the taxpayer (see above). (Code Sec. 42(i)(3)(A)) Under Code Sec. 42(i)(3)(B)(i), a unit is not treated as a low-income unit unless it is suitable for occupancy and used other than on a transient basis. The suitability of a unit for occupancy is determined under IRS regs prescribed taking into account local health, safety, and building codes. (Code Sec. 42(i)(3)(B)(ii)) Failure of one or more units to qualify as low-income units may result in a project’s ineligibility for the low-income housing credit, reduction in the amount of the credit, and/or recapture of previously allowed credits.

Under Code Sec. 42(m)(1), the owners of an otherwise-qualifying building are not entitled to low-income housing credits that are allocated to the building unless, among other requirements, the allocation is pursuant to a qualified allocation plan (QAP). A QAP provides standards by which a State or local housing credit agency (Agency) will make these allocations. A QAP also provides a procedure that an Agency must follow in monitoring for compliance with Code Sec. 42’s requirements and notifying IRS of noncompliance. (Code Sec. 42(m)(1)(B)(iii)) The procedures for monitoring compliance include performing physical inspections and low-income certification review. (Reg. § 1.42-5, the “compliance-monitoring regs”)

Specifically, for each low-income housing project, the existing compliance-monitoring regs require an Agency to:

…conduct on-site inspections of all buildings by the end of the second calendar year following the year the last building in the project is placed in service (the all-buildings requirement);
…for at least 20% of the project’s low-income units, inspect the units and review the low-income certifications, supporting documentation, and rent records for the tenants in those same units (the same-units requirement);
…conduct on-site inspections and low-income certification review at least once every three years after the initial on-site inspection;
…randomly select which low-income units and tenant records to inspect and review (the random-selection rule); and
…choose the low-income units and tenant records in a manner that will not give owners of low-income housing projects advance notice that a unit and tenant records for a particular year will or will not be inspected and reviewed (the no-notice rule); but reasonable notice is allowed so that the owner can notify tenants of the inspection of assemble records.

In 2012, IRS started a “Physical Inspection Pilot Program” in a number of states to reduce compliance costs by avoiding duplicative physical inspections. (Notice 2012-18, 2012-10 IRB) It essentially attempted to align some of the inspection requirements in the compliance-monitoring regs with other inspection requirements imposed by the Department of Housing and Urban Development (HUD). It also requested comments on the compliance-monitoring regs, including on whether the 20% rule for both physical inspections and low-income certification is appropriate, and whether the regs should provide an exception for inspections that are done under the protocol used for HUD inspections (the “Real Estate Assessment Center,” or REAC, protocol). The program wasn’t available after 2014. (Notice 2014-15, 2014-12 IRB 661)

While some commenters said that the 20% rule is appropriate, others said it was overly burdensome for larger properties. Other commenters said the regs should permit an Agency to satisfy the physical inspection requirement using the REAC protocol, noting that such would promote flexibility, lessen burden, and avoid multiple Federal inspections of a single property that benefits from HUD programs. Additionally, for larger properties, the minimum number of low-income units that an Agency must inspect under the REAC protocol may be fewer than under the 20% rule.

New guidance. The new regs revise and clarify the requirement to conduct physical inspections and review low-income certifications and other documentation. The final regs indicate that certain provisions are “reserved” and refer readers to the corresponding provisions in the temporary regs for additional guidance, and the proposed regs use the text of the temporary regs. (For clarity, citations throughout this article are to the temporary regs.) In multiple places, the temporary regs indicate that exceptions to certain rules may be provided in published guidance—and Rev Proc 2016-15, issued concurrently with the regs, provides additional guidance.

The regs authorize IRS to specify in guidance the minimum number of low-income units for which an Agency must conduct physical inspections and low-income certification review. (Reg. § 1.42-5T(b)(iii)(B)) IRS provides that guidance in Rev Proc 2016-15: the lesser of 20% of the low-income units in the project, rounded up to the nearest whole number of units, or the number of low-income units set forth in the chart provided in Rev Proc 2015-16, Sec. 4. The same rule is applied in Rev Proc 2016-15 to determine the minimum number of units that must undergo low-income certification review. An Agency is free, however, to conduct physical inspections or low-income certification review on a larger number of low-income units if it believes that to be appropriate. IRS also noted that it was concerned about application of the 20% rule in smaller projects and would consider whether to change the rule allowing same. (T.D. 9753)

The regs also authorize IRS to provide in guidance exceptions from, or alternative means of satisfying, the inspection provisions of Reg. § 1.42-5. (Reg. § 1.42-5T(a)(2)(iii)) IRS in fact does so in Rev Proc 2016-15, by providing that the REAC protocol is among the inspection protocols that satisfy both Reg. § 1.42-5(d) and the physical inspection requirements of Reg. § 1.42-5T(c)(2)(ii) and Reg. § 1.42-5T(c)(2)(ii). Vacant units are also subject to potential inspection when an Agency conducts a physical inspection under the REAC protocol. (Rev Proc 2016-15)

The regs continue to require that an Agency comply with the all-buildings requirement, above, unless otherwise provided in published guidance. However, Rev Proc 2016-15 provides such an exception for an Agency that uses the REAC protocol, under HUD oversight, to satisfy the physical inspection requirement. The inspection must satisfy a number of procedural and substantive requirements set out in Rev Proc 2016-15, Sec. 5. IRS reasoned that this exception is warranted by the fact that such inspections require federal agency oversight. (T.D. 9753)

In response to comments, the regs also end the “same units” requirement, above, by decoupling the physical inspection and low-income certification review (i.e., not requiring an Agency to conduct both inquiries with respect to the same units). If different units are in fact selected, the Agency must select them separately and randomly. (Reg. § 1.42-5T(b)(iii)(C)(1)) Additionally, the Agency may now conduct these inquiries at different times, provided that it still satisfies the applicable timeliness requirements set out in Reg. § 1.42-5T(c)(2)(ii)(A)(1) and Reg. § 1.42-5T(c)(2)(ii)(A)(2). The regs also strengthen the “no notice” rule by providing that reasonable notice is generally no more than 30 days (with limited exception for extraordinary circumstances such as natural disasters), but IRS specifically sought comments on whether the maximum amount of notice should be shortened. (Reg. § 1.42-5T(b)(iii)(C)(2))

Finally, the regs revise the current rules to clarify that a monitoring procedure must require that the owner certifications in Reg. § 1.42-5(c)(1) be made to and reviewed by the Agency at least annually covering each year of the 15-year compliance period.

Effective date. The temporary regs apply on Feb. 25, 2016 (i.e., their publication date) and expire on Feb. 22, 2019. (Reg. § 1.42-5T(i)) Rev Proc 2016-15 is also effective on Feb. 25, 2016. Agencies using the REAC protocol as part of the physical inspections pilot program may rely on the temporary regs and provisions in Rev Proc 2016-15 for on-site inspections and low-income certification review occurring between Jan. 1, 2015 and Feb. 25, 2016. (Reg. § 1.42-5T(h)(2); Rev Proc 2016-15, Sec. 6)

References: For the low-income housing credit, see FTC 2d/FIN ¶  L-15700  et seq.; United States Tax Reporter ¶  424.10; TaxDesk ¶  383,001  et seq.; TG ¶  15200  et seq.

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