A Case Study: Common Area Noncompliance
By: Andy Bowden, CAHEC Board of Directors
Did you know the IRS recently released a memorandum (PTMA-2019-04) providing guidance on common area noncompliance? To better explore some of the details outlined in PTMA-2019-04, let’s take a closer look at a recent example of common area noncompliance and how it applies.
In November, Spectrum Enterprises inspected a project in a state where we are the Authorized Delegate. The property consists of ten residential buildings and one community building, and had recently sustained a lot of damage due to severe storm conditions. Several units in nearly every building had been rendered uninhabitable for a short amount of time, but were now back online. Overall, the project looked great with the exception of a community building that had also sustained a lot of damage. Management stated that they had made the decision to forego repairing the community building to make sure they got all the residential units repaired by year-end.
The community building consists of a management office area and a maintenance garage. Management rationalized that since the management functions were being adequately handled at a nearby property and the maintenance area was still usable even though it had a lot of water damage, there was no effect on the tenants, and thus, no big hurry to complete repairs. Because 100% of the units were in service, they felt that there were no LIHTC compliance issues. They also felt that since the damage was relatively minor – window damage and water damage to roughly 10% of the interior – that it was deemed “de minimis” and therefore not reportable to the IRS.
In this case, we will be issuing an 8823, citing noncompliance with Uniform Physical Condition Standards (UPCS). The effect will be that the eligible basis of the property will be reduced by the cost of the community building and there will be a loss of credits and possible recapture unless the situation is remedied by December 31st, which is the end of their tax period.
In the past, we would have based our position on a combination of guidance from the 8823 Audit Guide, Section 42, and the regulations. However, the newly released IRS memorandum (PMTA-2019-04) perfectly addresses this type of situation.
To summarize the explanations contained in the memorandum: Common areas in a qualified low-income project are considered residential rental property if functionally related and subordinated to the qualified low-income project. Under Section 42 (d)(A) and (B), the eligible basis for a qualified low-income building includes the adjusted basis of the property used in common areas. Therefore, if a common area is non-compliant under the inspection standards during the compliance period, and if the noncompliance is uncorrected as of the close of the taxable year, the noncompliance should be treated as a reduction in the eligible basis of the building. In addition to creating a possible loss of credits in the current taxable period, a recapture event may be triggered.
The memorandum goes on to clarify that the reduction in eligible basis is not limited to the amount of the costs attributable to only the portion of the non-compliant common area, but instead includes the amount of the total costs of the specific common areas that caused the noncompliance. In other words, the eligible basis is reduced by the entire costs of the building rather than by just the costs associated with fixing the damage.
It is important that we familiarize ourselves with the information provided in this memorandum and reference it for any questions related to our LIHTC communities. For more information, please reference the memorandum directly.
Andy Bowden is the CPA President and Managing Partner of Spectrum Enterprises.