Article | Basics 6: "How Do the Watchmen Watch?" - State Compliance Monitoring Procedures
Apr 06, 2022
At any given time, tax credit properties all over the country are helping tens of thousands of households by providing decent, safe and sanitary housing that they can afford. A property can continue to do so if the responsible management professionals follow the basic rules of the program. Past articles in this series discussed building a library to assist in understanding the compliance rules as well as specific rules relating to determining income and student status for the tax credit program. Now we will cover how the government ensures that properties are compliant, and how we can get ahead of this process to fix any problems that arise. Specifically, we’ll discuss how tax credit properties are monitored by the government through regular inspections and how tax credit professionals can be prepared for these visits from regulatory monitors even before we know they are coming.
Inspection Basics
The IRS delegates the task of conducting regular visits to tax credit properties to state Housing Finance Agencies (HFAs). Each state has an HFA. Among other tasks, the HFA visits each property in their state at least once every three years. As the IRS expects the HFAs to monitor and interpret the federal rules and allows them to impose rules beyond the federal requirements, it is important for new tax credit professionals to identify their HFA. Locating and being familiar with any state HFA tax credit compliance manual, FAQ, or newsletters is a very good idea. This helps management know-how to meet the state agency’s requirements and will help make visits from the state go smoothly. States report noncompliance they find to the IRS on form 8823 and the IRS’ 8823 Guide provides instructions to the HFAs for completing this form and is very useful in understanding the IRS’ expectations for tax credit properties.
On their triannual visits, the state will review tenant files and check the physical condition of the property and units. In the past, the requirement was that a minimum of 20% of the tax credit units (rounded UP to the next whole unit) had to be reviewed, and the same units had to be chosen for file and physical review. In 2016 the minimum standard was temporarily adjusted to the LESSER of 20% or the number on the new chart (below). Analysis of the numbers shows that the minimum was 20% of the tax credit units until a project has 105 units. After that, the new chart provides a lesser minimum of units.
Except for properties with HUD or Rural Development funding, physical inspections will be conducted using the HUD standard Uniform Physical Conditions Standards (UPCS) protocol OR a local code. UPCS is part of the HUD REAC system. HUD provides UPCS documentation on their website that explains that protocol.
Recent Update!
The compliance monitoring regulation, published in 2019, eliminated the 20% aspect of the rule, and states were required to pick a minimum sample size based on the chart to the right. Many states realized that the new chart would represent a significant increase in work and that they may not have allocated staff time adequately - or even have enough personnel - to meet the new requirements. Efforts were made through the National Council of State Housing Agencies (NCSHA) to address their concerns with the IRS and seek amendment of the requirements. In July of 2020, the IRS re-established the 20% ceiling. The below changes, however, continue to apply:
- The new regulations no longer require that the state HFA examine the same units when conducting file reviews and physical inspections. In fact, they prohibit doing so, unless the inspections are conducted on the same day. This keeps the units unannounced for each part of the review.
- If units that are selected do not cover all buildings, the HFA must select some aspect to inspect buildings that will not have any units inspected. These can be building exterior, HVAC, or similar.
- The reasonable notice time that states are allowed to give of an upcoming inspection has been reduced from 30 days to 15.
- An exception exists for LIHTC/HUD properties that are monitored by HUD REAC inspections, which may use the REAC sampling methods and this means that often all buildings are not inspected.
- The HFA may not inform the owner which units will be inspected prior to the day of the inspection
Bonus | COVID 2022 Adjustments
During the COVID era, the IRS issued a series of Notices that waived some of the inspection rules. IRS Notice 2022-5 adjusted some provisions that affect the Treas. Reg 1.42-5 inspection rules through 2022. Correction periods were adjusted as well as an allowance for states to suspend physical inspections through 2022 if the HFA determines it is needed. All of the provisions of the Notice can be a bit complicated, so we have designed a chart to help. Download the chart HERE.
Helpful Hints
Here are some pointers to help a manager prepare for a visit from an HFA.
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Arrive on time for the audit.
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Have a place prepared for the reviewer to review files. Adequate light and a surface to work on are important. Even a folding table in a laundry room is better than nothing at a property without office or community room space.
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Have all files on hand.
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Find out if the auditor prefers the manager to stay close at hand to answer questions or would rather they wait to answer all their questions at once. This is a matter of individual auditor taste.
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Notify all residents of the physical inspection, giving sufficient time under the property lease and state law. Also, have keys on hand for all units. If the inspector cannot legally enter units, the state HFA is very likely to declare all of the inaccessible units noncompliant.
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Do not be defensive or argumentative. Make sure that all interaction with the reviewer is professional. If the auditor is wrong on a point, a chance to dispute the matter will come when the written report is received later. Many incorrect findings also disappear once an auditor has a chance to do some research of their own. Getting into a conflict does not serve anyone’s interests.
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Respond quickly to health and safety issues and inform the HFA immediately when these are addressed. The inspector will provide the timeframe for corrections, generally 24-72 hours.
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The HFA may send the report to the owner or a key person at the property management company that may not be the site manager. The site manager should make sure that they ask this person if the letter has arrived regularly until it comes. This prevents unnecessary delays in getting started on the fixes.
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If the auditor conducts an exit interview, begin corrections as soon as possible. If not, work should begin as soon as the letter is received. The state is required to give a limited time for corrections to be made before a form 8823 must be submitted to the IRS.
Correction Periods
The state HFA is required to inform the owner of the findings of the audit promptly. From the time of notification, the HFA will provide a correction period. This can be up to 90 days as the state dictates. If an owner/agent can make a case for unusual extenuating circumstances, the state may allow a total correction period not to exceed 6 months. It is in the property's best interest to make all corrections possible in the state-dictated correction period. This way the noncompliance will be reported to the IRS as "corrected" and may receive less scrutiny from the IRS and decrease the chance of a full audit.
Due Diligence and File Audits
To maintain compliance, the IRS emphasizes the need for due diligence. Chapter 3 of the 8823 Guide explains:
“Compliant behavior can be demonstrated when a LIHC property owner exercises ordinary business care and prudence in fulfilling its obligations. Due diligence can be demonstrated in many ways, including (but not limited to) establishing strong internal controls (policies and procedures) to identify, measure, and safeguard business operations and avoid material misstatements of LIHC property compliance or financial information.”
The Guide goes on to explain that “Internal controls” include:
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Separation of duties,
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Adequate supervision of employees,
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Management oversight and review (internal audits),
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Third-party verifications of tenant income,
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Independent audits, and
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Timely recordkeeping.”
Note the importance placed on internal and external audits commissioned by the owner. Each of the measures on the list relates to some degree to these types of file reviews. Smart owners incorporate file review systems into their procedures or contract with a reputable compliance firm to assist. This can include audits of files prior to household move-in or spot checks of a percentage of current household files. The 8823 Guide also discloses that an 8823 is not to be turned in if an issue is discovered and corrected by an owner’s agent prior to the HFA informing of an upcoming audit. This is a powerful allowance and it is therefore important for all professionals to work with company systems designed to provide internal controls and increase the chances that a visit from the HFA will go smoothly!
The above topic is just one of many to be discussed at this year's Compliance Summit Events. Check it out HERE!
There is a very good chance that the topic of this post is covered in an online on-demand course at Costello University.
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