In LIHTC compliance, the difference between a harmless practice and a serious violation can come down to a single regulatory detail. Each Compliance Stoplight Test presents a real-world scenario. What color is the compliance stoplight for this situation: Green Light (tax credits are safe), Yellow Light (proceed with caution), or Red Light (tax credit loss is imminent)?

Scenario

In a mixed-income LIHTC building, several income-qualified families occupy two-bedroom low-income units. At annual recertification, their incomes have increased above 140% of the applicable income limitation. A larger three-bedroom market-rate unit in the same building becomes available. The owner rents the three-bedroom unit to a new market-rate family.

Later, a one-bedroom market-rate unit in the same building becomes available. This unit is smaller than each of the over-income two-bedroom units. The owner rents the one-bedroom unit to a new market-rate family.

Without counting the over-income two-bedroom units as low-income units, the building's current applicable fraction is below the applicable fraction on which its tax credits are based.

What color is the compliance stoplight?

🟢 Green Light – Tax credits are safe
🟡 Yellow Light – Proceed with Caution
🔴 Red Light – Tax credit loss imminent

Food for thought: Does the Available Unit Rule treat the second vacancy differently from the first?

Stoplight Reveal

🔴 Red Light – Tax credit loss imminent

The later one-bedroom unit is smaller than the over-income two-bedroom units. Renting it to a nonqualified family causes the affected over-income units to lose their low-income status.

More Details

IRC §42(g)(2)(D) allows a properly qualified LIHTC unit to continue as a low-income unit after the family's income rises above 140% of the applicable income limitation, provided the rent remains restricted and the Available Unit Rule (AUR) is satisfied.

To continue treating an over-income unit as a low-income unit, the AUR generally requires comparable or smaller units in the same building to be rented to income-qualified families as they become available until the building's applicable fraction is restored.

For this purpose, comparability is measured using the same method used to determine qualified basis. IRS guidance also notes that bedroom count and comparable amenities may be used as a practical guide, but bedroom count alone is not the regulatory test.

In the first scenario, the available three-bedroom unit was larger than the over-income two-bedroom units. Because it was not comparable in size to or smaller than those units, renting it to a market-rate family did not cause the over-income units to lose their low-income status.

The second vacancy changes the result. The one-bedroom unit is smaller than the over-income two-bedroom units. When the owner rents it to a nonqualified family, the Available Unit Rule is violated.

Under Treas. Reg. §1.42-15(f), all over-income units in the building for which the available unit is comparable lose their low-income status. Here, that means all the affected two-bedroom units, not just one.

The loss of those units from the applicable-fraction calculation reduces the building's qualified basis below the amount supporting its claimed credits. That creates federal LIHTC credit consequences, potentially including recapture under Section 42(j), depending on the applicable year and circumstances.

The IRS illustrates this multiple-unit consequence in Publication 5913 ("the 8823 Guide"), Category 11i, Example 2: Comparable Units.

Compliance Insight

Under the Available Unit Rule, the size of each available unit matters. An earlier permissible market-rate rental does not eliminate the owner's obligation to rent later comparable or smaller available units to qualified families.

One smaller rental can cause multiple over-income units to lose their low-income status.

References

• IRC §42(g)(2)(D)(i)–(ii)
• Treas. Reg. §1.42-15(a)–(c), (f)
• IRS Publication 5913 (Rev. Jan. 2024), Category 11i, A.4–A.6 and C — Example 2: Comparable Units
• IRC §42(c)(1) and §42(j)

Did the result surprise you? Watch for next week's Compliance Stoplight Test.