Cutting Corners in Housing Credit Compliance – A Trap to Avoid

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Tax Credit Advisor, May 2009: In tough economic times, there’s the temptation to cut back on compliance in low-income housing tax credit (LIHTC) properties. Doing so is a mistake that will lead to financial losses in the long term. Additionally, corner-cutting in compliance can result in potentially catastrophic economic penalties for owners of LIHTC properties.

LIHTC compliance cost-saving measures tend to take place in the areas of oversight and supervision, mostly at the top-down level, though on-site cutbacks do occur. Compliance oversight protects against events that may occur as far as three years in the future. But while there may not be immediate negative impact from corner-cutting, a lot of dollars will be at risk in the long term if oversight is compromised today.

The attention paid by the Internal Revenue Service to the LIHTC program is likely to increase in the years ahead, partly due to inadequate governmental oversight that has contributed to the current economic crisis. In recognition of this, leading LIHTC investors, syndicators, owners, and managers are actually increasing their internal and contracted independent oversight of tax credit properties. Those program participants who cut back LIHTC on supervision and risk management misread today’s realities.

Compliance oversight shouldn’t be treated as an exercise in cost management and reduction. Owners who understand the importance and benefits of strong oversight generate much greater long-term value per project for investors. These owners today are positioning themselves for increased market share once the economy rebounds and more investors again seek out tax credit investments (which will happen).

Examples of Shortcuts

Cutting corners in compliance can occur at all levels – from the property site level all the way up to syndicators and investors. At the investor and syndicator level, recent trends include some firms reducing or eliminating corporate compliance and asset management staff, and terminating independent third-party reviews of LIHTC properties. At the site level, some general partners and management agents, in an effort to save money, are eliminating compliance oversight altogether. Corporate managers often try to cut costs by hiring staff not trained and qualified in screening renter applicants for tax credit eligibility. In addition, some fail to hire qualified management personnel, either at the site or corporate level, creating significant potential for tax credit rule violations, particularly requirements unrelated to resident eligibility. Issues such as excess rents, inappropriate use of common area, and failure to maintain the habitability of the property and its units in accordance with physical and code standards become major concerns at projects with lax risk management practices. Often, these problems pose much greater jeopardy to the credits themselves than do tenant eligibility issues.

Oversight of LIHTC properties by the IRS and state housing credit agencies (HCAs) will intensify in the near future, due partly to the adverse publicity over inadequate federal regulatory oversight of the financial services industry. At such a time, reducing LIHTC compliance capability is a recipe for disaster.

Saving a few short-term dollars by reducing risk management and compliance oversight is a risky strategy that can lead to:

  • An increase in the number of findings of noncompliance at a property reported to the IRS by HCAs on Form 8823;
  • An increased risk to investor return;
  • A damaged reputation, including issues relating to fiduciary responsibilities; and,
  • Long-term damage to the LIHTC program itself.

On the flip side, owners, managers, and syndicators that protect their investors during tough times will place themselves in a much more competitive position after the dissipation of the current economic downturn and equity crunch. Farsighted investors, owners, and managers are seeing today’s challenges as an opportunity to separate themselves from the pack.

Potential Damage

One problem is that a number of corporate investor chief financial officers and asset management directors have limited understanding of the financial risks from noncompliance in the tax credit properties in which they invest.

The following example illustrates the potential loss of housing credits from even a simple noncompliance event:

    A fully low-income, 100-unit LIHTC building has an initial tax credit year of 2003. The state HCA discovers that one unit as of 12/31/08 was occupied by an ineligible resident. Each unit in the building generates $8,000 in housing credits per year. The consequence of this one incident of noncompliance is the loss of $8,000 in tax credits for 2008 attributable to the ineligible unit, plus recapture of the accelerated portion of tax credits claimed for the unit since 2003, plus interest, or $13,333 in tax credits plus interest. This recapture occurs even if the unit was in compliance during the years prior to the year of the noncompliance event.


The preceding example illustrates that just one ineligible unit can generate substantial investment losses – here, more than $21,000 in lost tax credits plus interest. If this same building has multiple ineligible units – not beyond the realm of possibility with lax oversight – the loss would be substantially greater.

Guidance on Due Diligence

The IRS has outlined the kinds of “due diligence” that it expects of LIHTC project owners in the area of compliance. When conducting an examination of a taxpayer’s return, IRS agents routinely evaluate the taxpayer’s internal controls (i.e. the procedures the taxpayer has put in place to safeguard business operations). This examination looks at the due diligence of the taxpayer.

Following are some of the issues likely to be raised during an IRS examination:

  • What oversight does the LIHTC owner provide to the property manager? Is the manager trained?
  • Are there written procedures in place for qualifying households? Who makes sure these procedures are followed? Is there a review process?
  • Does the owner use standardized forms?
  • Does the owner conduct independent audits?
  • What happens if noncompliance occurs?
  • Are households monitored for changes in family size?
  • How are the files maintained?

The IRS has made it clear that the degree of due diligence by a taxpayer in filing an accurate tax return and satisfying federal tax law heavily influences the severity of the penalty that is imposed on the taxpayer for a noncompliance event.

Participants in the tax credit program at all levels must continue to make sure that they have proper compliance oversight and risk management procedures in place. The potential long-term losses from violations far outweigh the short-term savings realized.

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].