In the complex world of low-income housing tax credits (LIHTCs), numerous stakeholders and countless pitfalls can sidetrack any project. From investors selling tax credits to developers building multifamily housing, each entity has its own priorities and varying levels of expertise on how to execute its role effectively.
The reality is there are key nuances at every step along the way that each stakeholder must be aware of and have the understanding to navigate if they hope to have the project meet its goals.
In the development of LIHTC properties, it all begins with the projections. Unfortunately, in many cases developers don’t know exactly what they’re agreeing to, much less how to accurately project their fees, overruns, and timelines. A majority of developers do not receive their fees in a timely fashion due to variances between the projections and the actual outcomes.
To help key stakeholders involved in the tax credit process, experts at PKF O’Connor Davies, an accounting and advisory firm, have outlined a number of potential pitfalls and identified key steps organizations should take to ensure their tax credit projects finish where they began.
Eligible and ineligible expenses
LIHTCs are established based on eligible development costs. When a cost shifts from eligible to ineligible, it’s still a development cost but doesn’t generate credit, and, therefore, equity or other funds must be used to pay for it. Good projections are the foundation of avoiding these cost shifts—there’s only so much you can do during development to change costs.
For example, suppose $10,000 is projected for a market study (an eligible cost) and $5,000 is allocated for marketing (an ineligible cost). If the market study ends up only costing $5,000, the remaining $5,000 should not be spent on general marketing. Even though the total spending would still be $15,000, the eligible basis is not the same.
In navigating these expenses, having experts to oversee costs early in the process is essential. Regular check-ins can help identify unfavorable shifts and provide guidance on how to redirect costs and maintain eligible development costs.
Occupancy issues
The ultimate goal of any project should always be to reach 100% occupancy in the first year of operations. Developers have gotten smarter in recent years about moving tenants around to maximize the number of buildings that reach peak occupancy—for example, adjusting so two buildings have 100% occupancy and receive credits instead of four buildings at half occupancy.
It’s essential to know and communicate occupancy requirements as stipulated on Form 8609 Part 2—specifically the 20/50 vs. 40/60 requirement. It’s important to note that this election is irrevocable. It’s best to consult your accountant and the investor partner before filing this form with the IRS. If there are concerns about failing to meet occupancy requirements or finding enough properly qualified tenants, communicate with investors early in the marketing and rent-up process. They may be able to increase marketing or utilize other outreach efforts to attract additional qualified tenants and increase occupancy rates.
Compliance issues
To combat increasing regulatory burdens along with states issuing more 8823 forms for immaterial issues, many investors require third-party inspections to ensure compliance. But these inspections don’t help with errors made after lease-up. Common pitfalls include over-income tenants, inadequate tenant files, charging too much for rent, violations of the rules governing next available unit, full-time students, or vacant units.
Ideally, it’s best to avoid Form 8823 to begin with, but receiving one does not automatically mean the need to reverse credits. Timing is crucial—there’s usually 90 days to correct, depending on safety issues. Armed with the necessary documentation and background, expert advisors can help fight regulatory overzealousness and give you a better idea of what impact an 8823 will have on the overall project.
Best practices
With these triggering events in mind, here are three best practices to keep your projects on track and predictable.
1. Communicate early and often. Communication through—and beyond—lease-up is essential. Constant interaction between investor and developer is a must. Delays in construction can postpone lease-up, and credits may be delayed. That can derail investor’s income and tax projections. It may also lead to out-of-pocket demands from investors to developers for reimbursement. Groups need notice to plan for these situations.
The majority of essential communication takes place during preconstruction, construction, and lease-up periods. That’s when ineligible and eligible costs will be determined and cost overruns will be addressed. There should still be some communication among continuing stakeholders after that. For example, if an organization receives a grant, it may help the operating partnership but ultimately hurt investors in the form of higher taxes. Investors may prefer loans to cover costs instead of grants. Regular communication and an overseeing partner can assist in navigating these complicated situations involving several stakeholders.
2. Identify potential problems early. LIHTC projects are complicated, and there’s a lot that can go wrong—construction delays, credit delivery delays, lease-up delays, compliance issues, etc. But they don’t all necessarily go hand in hand. There could be cost overruns with a project that finishes early or lease-up issues.
One best practice is to bring in experts like a CPA or attorney to assist in the process early. Ideally, these team members will have experience with similar projects. Armed with a bit of prior knowledge and a better understanding of where the project has been and where it’s headed, experts can offer more valuable guidance and provide more tailored solutions.
3. Forge key partnerships. No matter how much experience you have in the affordable housing world, every project is different with so many variables – partners, construction process, tenants, etc. Having a CPA, housing consultant, syndicator, or other partner who can help keep the big picture in perspective from the beginning of a project to lease-up and beyond is essential. Better still is to have a professional with expertise in relationships-- someone who has worked in other aspects of affordable housing and who can have strategic conversations with different people at different levels.
Stewart A. Grubman is the partner-in-charge of the PKF O’Connor Davies’ Bethesda, Md., office. He has over 30 years of experience in public accounting. His main focus is on auditing and tax services for affordable and special-needs housing. Grubman is a specialist in insured and subsidized multifamily housing with expertise in the areas of syndicated lower-tier and upper-tier partnerships, low-income housing tax credits, Department of Housing and Urban Development, Department of Agriculture Rural Development, and state-financed housing programs.
