x The Co$t of Noncompliance - Spectrum Enterprises


The Co$t of Noncompliance

Written by Erik Whitton, Originally published in Tax Credit Advisor Magazine

The Low Income Housing Tax Credit program provides the necessary capital for many affordable housing properties be be developed.  As Steve Rosenblatt (owner & president of Spectrum Seminars, Inc.) teaches throughout the nation in his c3p courses, “the price of credits is compliance.”  In other words, tax credits may be claimed as long as the property meets compliance requirements.  

Where an owner fails to maintain compliance, the state allocating agency may file an IRS Form 8823 (Report of Noncompliance) and the IRS may, in turn, disallow or recapture credits.  Even if the state agency and/or IRS does not discover noncompliance via the 8823 form, many partnership agreements stipulate that the investor will audit tenant files for compliance and require an adjuster penalty paid by the owner for units that are deemed at risk for credit loss.  

Many owners, developers, and even managers may not be aware of the actual cost associated with losing tax credits due to non-compliance.  In my experience, the dollar amount attached to noncompliance is not really known by a party until they have suffered a credit loss; in other words, too late!  To underscore the importance of partnering with qualified & experienced individuals this article will present hypothetical scenarios involving noncompliance events and the potential cost to the property owner.

Credit Value per Unit

To begin understanding the impact of credit loss due to noncompliance, you need arrive at the credit value per unit.  Simply divide the total amount of annual tax credits by the number of affordable units.

Example: A property with $600,000 in annual credits and 40 affordable units =  $15,000 per unit per year (or $1,250 per month).  

Compliance Period, Credit Period, & Accelerated Credits

The IRS defines the credit period for a building as “the period of 10 taxable years beginning with” either the year the building is placed in service or the succeeding taxable year (owners make this election on the IRS 8609 form).  

The IRS defines the compliance period  as “the period of 15 taxable years beginning with the 1st taxable year of the credit period.”

A property must maintain compliance requirements during years 11-15 even though no credits are being claimed.  One-third of the credits that were claimed in years 1-10 are referred to as the accelerated portion inasmuch as they are generally claimed prior to the compliance requirement ending.  Therefore, it is important to think of credits in terms of thirds.

Non Compliance in Year 1

ABC Apartments (40 units; $600k annual credit) is constructed during 2007; the owner chooses 2008 as the first credit year. Due to an error in processing the move in file, this household is over the income limit.  They occupy the unit from February 1, 2008 until February 1, 2009.  The unit is re-rented to an eligible household on April 1, 2009.  The potential credit loss is calculated as follows:

a) All of year 1 ($15,000), and

b) January – March in year 2 ($1250 x 3 = $3,750), and

c) The owner loses the accelerated portion of the credit attached to that unit.

The owner may claim $0 in year 1; $7,500 in year 2; and $10,000 (2/3 full credit value) in years 3-15 for a total of $137,500 over 15 years.  If the unit had been in compliance from the beginning the owner could have claimed $15,000 per year for 10 years equaling $150,000 over 10 years.  In addition to the $12,500 in lost credit the owner must also consider the time value of money that has been lost (i.e. credits must be claimed in years 1-15 instead of 1-10).

Non Compliance in Year 5
If a non-eligible household moves into the property during year 5 the owner loses credits starting the month of move in until the unit becomes occupied by a qualified household.  In addition, the owner could lose the accelerated portion of the credit claimed in years 1-4 (the IRS may not recapture credits if the owner corrects a noncompliance event within a reasonable period after it is discovered or should have been discovered).

Example 2: Unit 201 becomes occupied by an ineligible household on May 1, 2012.  The owner offers and the family accepts an incentive to vacate the unit.  On February 1, 2013 the units is re-rented to an eligible household.  

The owner loses credit for 8 months in 2012 and 1 month in 2013 ($11,250).  In addition to this, the owner could face recapture on the accelerated portion of credits claimed in years 1-4  (the maximum recapture exposure is $30,000 plus interest and possible penalties).  

Finally, the owner may lose the ability to claim the accelerated portion of the credit from 2012 – forward.

Non Compliance in Year 12

Normally, all credits are claimed in years 1-10.  However, the owner must maintain compliance for 15 years.  What happens if an error is made after all credits have been claimed?  

Example 3.  Unit 301 becomes occupied by an over income household from February 1, 2019 until February 1, 2020.    

In a scenario such as this the owner faces possible recapture of credits already claimed.  After year 10 the maximum recapture exposure amount begins to decrease.  In this example the recapture exposure is $30,000 plus interest and possible penalties.  

Lessons Learned

The scenarios used in this article are very simple in order to illustrate how to calculate the potential loss of credit due to noncompliance.  Where we discuss a single ineligible household we must stress how rare it is to witness isolated incidents of noncompliance.  These problems are often compounded by others.          

Take a moment to consider all of the parties involved in a typical tax credit property; the developer, engineer, architect, accountant, attorney, etc.  There is no job with more credits at stake than with the on-site leasing staff – yet these are the positions most often filled with inexperienced, untrained, or unsupervised individuals.  

Now that we have illustrated the potential cost of credit loss due to noncompliance an owner should weigh the benefits of hiring a management company well versed in tax credit compliance against a company that is cheaper but offers less experience & oversight.  And, despite a large company’s lengthy tax credit pedigree, it is crucial to know that the on-site employee(s) assigned to your site are sufficiently trained, experienced, and supervised.  

Knowing how to factor the potential cost of noncompliance should assist an owner is weighing the cost benefit analysis of sending managers to routine training (in light of recent legislative changes impacting compliance regulations we suggest annual training).  Owners should also consider the benefits of tax credit compliance software and using outside compliance consultants.  

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