Preventive MedicinePreparing a Tax Credit Property for the State Agency’s Physical Inspection

By
6 min read

By A.J. Johnson

Tax Credit Advisor, August 2010: Federal low-income housing tax credit properties must ensure compliance in three major areas – affordability, eligibility, and habitability – to prevent the loss of tax credits. Rents must be properly restricted, residents

State housing credit agencies (HCAs) must inspect each LIHTC property at least once every three years. During this inspection, the HCA must review at least 20% of the tenant files, physically inspect the same 20% of units, and inspect all common and public use areas. File reviews and physical inspection may be done at different times and by different people. The HCA must report incidents of noncompliance to the Internal Revenue Service on Form 8823, which may lead to a loss of tax credits for the property. Noncompliance that is corrected before the HCA’s review can prevent the issuance of an 8823.

HCAs must assess whether LIHTC properties are in safe, decent, sanitary condition, and in good repair, based on either the U.S. Department of Housing and Urban Development’s Uniform Physical Condition Standards (UPCS) or state/local inspection standards [see IRS Regulation 1.42-5(d)(2)]. The HCA’s qualified allocation plan should identify which standard is to be used.

The HCA may report physical deficiencies, discovered either from its own inspection of the property, or from information provided on the owner’s Annual Owner Certification (AOC) form.
The physical inspection must cover:

  • The site;
  • Building exterior;
  • Building systems;
  • Dwelling units;
  • Common areas; and,
  • Health and safety concerns.

Before the day of the HCA’s physical inspection, the management of an LIHTC development should thoroughly inspect the property. This “pre-inspection” should cover the site, all building exteriors, all building systems, all common areas, and all housing units. Areas within a building that are not residential units are considered common areas; the inspector must have access to all these areas. The pre-inspection should be completed using the same standard that the HCA will use in its inspection – either UPCS or state/local standards.

Any inspectable item at a property must function as designed by the manufacturer. For example, while the code does not require that each unit be equipped with a microwave oven, if an apartment has a microwave, it must work as intended.

The HCA’s physical inspection is “hands-on” -the inspector will physically test the function of all windows, doors, fixed lighting, stoves, etc. Management staff should do the same in its pre-inspection.

Keep in mind that all vacant units should be pre-inspected as well. The IRS has made it clear that a vacant unit that is not suitable for occupancy will be considered a “down” unit and reported as out of compliance. Allowing for reasonable turnover time (e.g., two weeks), all vacant units should be ready for occupancy.

Examples of Common Deficiencies

Following are examples of areas where management can take steps to prepare for the HCA’s visit and prevent the issuance of an 8823 (and correct ahead if necessary):

  • Water Heater: Make sure that the pressure relief valve extends to within 18 inches of the floor;
  • Water Heaters and Furnaces: Vent stacks on gas-operated water heaters or furnaces should be properly aligned;
  • Baseboard Heaters: All baseboard heaters must have covers;
  • Electrical Panels: Access to electrical panels must not be blocked by furniture or other items;
  • Doors: Factory-installed seals on exterior doors, such as building or unit doors, must be in place and undamaged; security doors must be operable and not have dual-side key locks; exterior door hardware locks or latches must function as designed;
  • Kitchen: All stove burners must work;
  • Plumbing: There should be no leaks in pipes and faucets;
  • Clothes Dryers: Make sure these are properly vented to the outside (either from units or laundry rooms);
  • Trash Chutes: Be sure hardware is in place and that the chute door closes properly;
  • Trash Receptacles: These must be adequately sized for the property and cannot be overflowing; and,
  • Electrical Outlet and Switch Plate Covers: These cannot be cracked or broken.

Exigent Health and Safety Issues

Management staff should pay particular attention to potential “exigent health and safety” issues during the pre-inspection. These urgent issues requiring immediate action, if discovered and reported by the HCA, have the highest potential for triggering additional IRS scrutiny. Examples of serious violations are:

  • Propane, natural, or methane gas leaks;
  • Exposed wires or open electrical panels;
  • Water leaks on or near electrical equipment;
  • Blocked or unusable emergency or fire exits;
  • Blocked fire escapes or ladders;
  • Missing or misaligned chimney for gas-fired water heaters or HVAC units;
  • Window security bars preventing exit;
  • Expired fire extinguishers; and,
  • Inoperative or missing smoke detectors.

When preparing for the HCA’s inspection, give special attention to:

  1. Electrical: All electrical boxes, panel boxes, fuse boxes, disconnect boxes, timer boxes, etc., are subject to inspection, regardless of the location. Boxes will be inspected even if behind locked doors; they must be available to the inspector. Electrical panels and fuse boxes must be available for inspection, whether secured or unsecured. All other electrical boxes, disconnects, timers, etc., will not be opened by the inspector and no deficiency will be cited if the box is secured at the time of the inspection.
  2. Blocked Egress: All living areas/rooms in a unit and all common area rooms must have two independent and unimpeded means of egress (escape) if so designed. Exempt are windows above the third floor that do not serve as a means of access to a designed escape route. If local code differs from this standard, a copy of the local standard should be provided.

Inspection Day Tips

On the day of the HCA’s inspection, make sure that you have system certificates available, as well as unit sizes, rent roll, and site map.

In addition:

  • Do not try to postpone the inspection indefinitely.The IRS recommends that the state accept no more than a 45-day delay;
  • Do not schedule other maintenance/service of any inspectable items for the day of the inspection, such as elevators, etc. Items “out of order” for maintenance will be considered inoperable;
  • Make sure that items that were worked on by maintenance staff prior to the HCA’s inspection have been completely placed back in working order; and,
  • Carry a notepad and camera during the inspectionto document any findings.

The physical inspection portion of the state credit agency’s LIHTC review is critical to the ability of a property to claim its tax credits. Preparation in this area will go a long way toward preventing 8823s and protecting the equity investor’s tax credits.

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, ajjohn@cox.net.