[Code of Federal Regulations]
[Title 26, Volume 1]
[Revised as of April 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.42-5]

[Page 151-157]
 
                       TITLE 26--INTERNAL REVENUE
 
     CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
 
PART 1--INCOME TAXES--Table of Contents
 
Sec. 1.42-5  Monitoring compliance with low-income housing credit requirements.

    (a) Compliance monitoring requirement--(1) In general. Under section 
42(m)(1)(B)(iii), an allocation plan is not qualified unless it contains 
a procedure that the State or local housing credit agency (``Agency'') 
(or an agent of, or other private contractor hired by, the Agency) will 
follow in monitoring for noncompliance with the provisions of section 42 
and in notifying the Internal Revenue Service of any noncompliance of 
which the Agency becomes aware. These regulations only address 
compliance monitoring procedures required of Agencies. The regulations 
do not address forms and other records that may be required by the 
Service on examination or audit. For example, if a building is sold or 
otherwise transferred by the owner, the transferee should obtain from 
the transferor information related to the first year of the credit 
period so that the transferee can substantiate credits claimed.
    (2) Requirements for a monitoring procedure--(i) In general. A 
procedure for monitoring for noncompliance under section 
42(m)(1)(B)(iii) must include--
    (A) The recordkeeping and record retention provisions of paragraph 
(b) of this section;
    (B) The certification and review provisions of paragraph (c) of this 
section;
    (C) The inspection provision of paragraph (d) of this section; and
    (D) The notification-of-noncompliance provisions of paragraph (e) of 
this section.
    (ii) Order and form. A monitoring procedure will meet the 
requirements of section 42 (m)(1)(B)(iii) if it contains

[[Page 152]]

the substance of these provisions. The particular order and form of the 
provisions in the allocation plan is not material. A monitoring 
procedure may contain additional provisions or requirements.
    (b) Recordkeeping and record retention provisions--(1) Recordkeeping 
provision. Under the recordkeeping provision, the owner of a low-income 
housing project must be required to keep records for each qualified low-
income building in the project that show for each year in the compliance 
period--
    (i) The total number of residential rental units in the building 
(including the number of bedrooms and the size in square feet of each 
residential rental unit);
    (ii) The percentage of residential rental units in the building that 
are low-income units;
    (iii) The rent charged on each residential rental unit in the 
building (including any utility allowances);
    (iv) The number of occupants in each low-income unit, but only if 
rent is determined by the number of occupants in each unit under section 
42(g)(2) (as in effect before the amendments made by the Omnibus Budget 
Reconciliation Act of 1989);
    (v) The low-income unit vacancies in the building and information 
that shows when, and to whom, the next available units were rented;
    (vi) The annual income certification of each low-income tenant per 
unit. For an exception to this requirement, see section 42(g)(8)(B) 
(which provides a special rule for a 100 percent low-income building);
    (vii) Documentation to support each low-income tenant's income 
certification (for example, a copy of the tenant's federal income tax 
return, Forms W-2, or verifications of income from third parties such as 
employers or state agencies paying unemployment compensation). For an 
exception to this requirement, see section 42(g)(8)(B) (which provides a 
special rule for a 100 percent low-income building). Tenant income is 
calculated in a manner consistent with the determination of annual 
income under section 8 of the United States Housing Act of 1937 
(``Section 8''), not in accordance with the determination of gross 
income for federal income tax liability. In the case of a tenant 
receiving housing assistance payments under Section 8, the documentation 
requirement of this paragraph (b)(1)(vii) is satisfied if the public 
housing authority provides a statement to the building owner declaring 
that the tenant's income does not exceed the applicable income limit 
under section 42 (g);
    (viii) The eligible basis and qualified basis of the building at the 
end of the first year of the credit period; and
    (ix) The character and use of the nonresidential portion of the 
building included in the building's eligible basis under section 42 (d) 
(e.g., tenant facilities that are available on a comparable basis to all 
tenants and for which no separate fee is charged for use of the 
facilities, or facilities reasonably required by the project).
    (2) Record retention provision. Under the record retention 
provision, the owner of a low-income housing project must be required to 
retain the records described in paragraph (b)(1) of this section for at 
least 6 years after the due date (with extensions) for filing the 
federal income tax return for that year. The records for the first year 
of the credit period, however, must be retained for at least 6 years 
beyond the due date (with extensions) for filing the federal income tax 
return for the last year of the compliance period of the building.
    (3) Inspection record retention provision. Under the inspection 
record retention provision, the owner of a low-income housing project 
must be required to retain the original local health, safety, or 
building code violation reports or notices that were issued by the State 
or local government unit (as described in paragraph (c)(1)(vi) of this 
section) for the Agency's inspection under paragraph (d) of this 
section. Retention of the original violation reports or notices is not 
required once the Agency reviews the violation reports or notices and 
completes its inspection, unless the violation remains uncorrected.
    (c) Certification and review provisions--(1) Certification. Under 
the certification provision, the owner of a low-income housing project 
must be required to certify at least annually to the Agency

[[Page 153]]

that, for the preceding 12-month period--
    (i) The project met the requirements of:
    (A) The 20-50 test under section 42 (g)(1)(A), the 40-60 test under 
section 42 (g)(1)(B), or the 25-60 test under sections 42 (g)(4) and 142 
(d)(6) for New York City, whichever minimum set-aside test was 
applicable to the project; and
    (B) If applicable to the project, the 15-40 test under sections 
42(g)(4) and 142 (d)(4)(B) for ``deep rent skewed'' projects;
    (ii) There was no change in the applicable fraction (as defined in 
section 42(c)(1)(B)) of any building in the project, or that there was a 
change, and a description of the change;
    (iii) The owner has received an annual income certification from 
each low-income tenant, and documentation to support that certification; 
or, in the case of a tenant receiving Section 8 housing assistance 
payments, the statement from a public housing authority described in 
paragraph (b)(1)(vii) of this section. For an exception to this 
requirement, see section 42(g)(8)(B) (which provides a special rule for 
a 100 percent low-income building);
    (iv) Each low-income unit in the project was rent-restricted under 
section 42(g)(2);
    (v) All units in the project were for use by the general public (as 
defined in Sec. 1.42-9), including the requirement that no finding of 
discrimination under the Fair Housing Act, 42 U.S.C. 3601-3619, occurred 
for the project. A finding of discrimination includes an adverse final 
decision by the Secretary of the Department of Housing and Urban 
Development (HUD), 24 CFR 180.680, an adverse final decision by a 
substantially equivalent state or local fair housing agency, 42 U.S.C. 
3616a(a)(1), or an adverse judgment from a federal court;
    (vi) The buildings and low-income units in the project were suitable 
for occupancy, taking into account local health, safety, and building 
codes (or other habitability standards), and the State or local 
government unit responsible for making local health, safety, or building 
code inspections did not issue a violation report for any building or 
low-income unit in the project. If a violation report or notice was 
issued by the governmental unit, the owner must attach a statement 
summarizing the violation report or notice or a copy of the violation 
report or notice to the annual certification submitted to the Agency 
under paragraph (c)(1) of this section. In addition, the owner must 
state whether the violation has been corrected;
    (vii) There was no change in the eligible basis (as defined in 
section 42(d)) of any building in the project, or if there was a change, 
the nature of the change (e.g., a common area has become commercial 
space, or a fee is now charged for a tenant facility formerly provided 
without charge);
    (viii) All tenant facilities included in the eligible basis under 
section 42(d) of any building in the project, such as swimming pools, 
other recreational facilities, and parking areas, were provided on a 
comparable basis without charge to all tenants in the building;
    (ix) If a low-income unit in the project became vacant during the 
year, that reasonable attempts were or are being made to rent that unit 
or the next available unit of comparable or smaller size to tenants 
having a qualifying income before any units in the project were or will 
be rented to tenants not having a qualifying income;
    (x) If the income of tenants of a low-income unit in the building 
increased above the limit allowed in section 42(g)(2)(D)(ii), the next 
available unit of comparable or smaller size in the building was or will 
be rented to tenants having a qualifying income;
    (xi) An extended low-income housing commitment as described in 
section 42(h)(6) was in effect (for buildings subject to section 
7108(c)(1) of the Omnibus Budget Reconciliation Act of 1989, 103 Stat. 
2106, 2308-2311), including the requirement under section 
42(h)(6)(B)(iv) that an owner cannot refuse to lease a unit in the 
project to an applicant because the applicant holds a voucher or 
certificate of eligibility under section 8 of the United States Housing 
Act of 1937, 42 U.S.C. 1437f (for buildings subject to section 
13142(b)(4) of the Omnibus Budget Reconciliation Act of 1993, 107 Stat. 
312, 438-439); and

[[Page 154]]

    (xii) All low-income units in the project were used on a 
nontransient basis (except for transitional housing for the homeless 
provided under section 42(i)(3)(B)(iii) or single-room-occupancy units 
rented on a month-by-month basis under section 42(i)(3)(B)(iv)).
    (2) Review. The review provision must--
    (i) Require that the Agency review the certifications submitted 
under paragraph (c)(1) of this section for compliance with the 
requirements of section 42;
    (ii) Require that with respect to each low-income housing project--
    (A) The Agency must conduct on-site inspections of all buildings in 
the project by the end of the second calendar year following the year 
the last building in the project is placed in service and, for at least 
20 percent of the project's low-income units, inspect the units and 
review the low-income certifications, the documentation supporting the 
certifications, and the rent records for the tenants in those units; and
    (B) At least once every 3 years, the Agency must conduct on-site 
inspections of all buildings in the project and, for at least 20 percent 
of the project's low-income units, inspect the units and review the low-
income certifications, the documentation supporting the certifications, 
and the rent records for the tenants in those units; and
    (iii) Require that the Agency randomly select which low-income units 
and tenant records are to be inspected and reviewed by the Agency. The 
review of tenant records may be undertaken wherever the owner maintains 
or stores the records (either on-site or off-site). The units and tenant 
records to be inspected and reviewed must be chosen in a manner that 
will not give owners of low-income housing projects advance notice that 
a unit and tenant records for a particular year will or will not be 
inspected and reviewed. However, an Agency may give an owner reasonable 
notice that an inspection of the building and low-income units or tenant 
record review will occur so that the owner may notify tenants of the 
inspection or assemble tenant records for review (for example, 30 days 
notice of inspection or review).
    (3) Frequency and form of certification. A monitoring procedure must 
require that the certifications and reviews of paragraph (c)(1) and (2) 
of this section be made at least annually covering each year of the 15-
year compliance period under section 42(i)(1). The certifications must 
be made under penalty of perjury. A monitoring procedure may require 
certifications and reviews more frequently than on a 12-month basis, 
provided that all months within each 12-month period are subject to 
certification.
    (4) Exception for certain buildings--(i) In general. The review 
requirements under paragraph (c)(2)(ii) of this section may provide that 
owners are not required to submit, and the Agency is not required to 
review, the tenant income certifications, supporting documentation, and 
rent records for buildings financed by the Rural Housing Service (RHS), 
formerly known as Farmers Home Administration, under the section 515 
program, or buildings of which 50 percent or more of the aggregate basis 
(taking into account the building and the land) is financed with the 
proceeds of obligations the interest on which is exempt from tax under 
section 103 (tax-exempt bonds). In order for a monitoring procedure to 
except these buildings, the Agency must meet the requirements of 
paragraph (c)(4)(ii) of this section.
    (ii) Agreement and review. The Agency must enter into an agreement 
with the RHS or tax-exempt bond issuer. Under the agreement, the RHS or 
tax-exempt bond issuer must agree to provide information concerning the 
income and rent of the tenants in the building to the Agency. The Agency 
may assume the accuracy of the information provided by RHS or the tax-
exempt bond issuer without verification. The Agency must review the 
information and determine that the income limitation and rent 
restriction of section 42 (g)(1) and (2) are met. However, if the 
information provided by the RHS or tax-exempt bond issuer is not 
sufficient for

[[Page 155]]

the Agency to make this determination, the Agency must request the 
necessary additional income or rent information from the owner of the 
buildings. For example, because RHS determines tenant eligibility based 
on its definition of ``adjusted annual income,'' rather than ``annual 
income'' as defined under Section 8, the Agency may have to calculate 
the tenant's income for section 42 purposes and may need to request 
additional income information from the owner.
    (iii) Example. The exception permitted under paragraph (c)(4)(i) and 
(ii) of this section is illustrated by the following example.

    Example. An Agency selects for review buildings financed by the RHS. 
The Agency has entered into an agreement described in paragraph 
(c)(4)(ii) of this section with the RHS with respect to those buildings. 
In reviewing the RHS-financed buildings, the Agency obtains the tenant 
income and rent information from the RHS for 20 percent of the low-
income units in each of those buildings. The Agency calculates the 
tenant income and rent to determine whether the tenants meet the income 
and rent limitation of section 42 (g)(1) and (2). In order to make this 
determination, the Agency may need to request additional income or rent 
information from the owners of the RHS buildings if the information 
provided by the RHS is not sufficient.

    (5) Agency reports of compliance monitoring activities. The Agency 
must report its compliance monitoring activities annually on Form 8610, 
``Annual Low-Income Housing Credit Agencies Report.''
    (d) Inspection provision--(1) In general. Under the inspection 
provision, the Agency must have the right to perform an on-site 
inspection of any low-income housing project at least through the end of 
the compliance period of the buildings in the project. The inspection 
provision of this paragraph (d) is a separate requirement from any 
tenant file review under paragraph (c)(2)(ii) of this section.
    (2) Inspection standard. For the on-site inspections of buildings 
and low-income units required by paragraph (c)(2)(ii) of this section, 
the Agency must review any local health, safety, or building code 
violations reports or notices retained by the owner under paragraph 
(b)(3) of this section and must determine--
    (i) Whether the buildings and units are suitable for occupancy, 
taking into account local health, safety, and building codes (or other 
habitability standards); or
    (ii) Whether the buildings and units satisfy, as determined by the 
Agency, the uniform physical condition standards for public housing 
established by HUD (24 CFR 5.703). The HUD physical condition standards 
do not supersede or preempt local health, safety, and building codes. A 
low-income housing project under section 42 must continue to satisfy 
these codes and, if the Agency becomes aware of any violation of these 
codes, the Agency must report the violation to the Service. However, 
provided the Agency determines by inspection that the HUD standards are 
met, the Agency is not required under this paragraph (d)(2)(ii) to 
determine by inspection whether the project meets local health, safety, 
and building codes.
    (3) Exception from inspection provision. An Agency is not required 
to inspect a building under this paragraph (d) if the building is 
financed by the RHS under the section 515 program, the RHS inspects the 
building (under 7 CFR part 1930), and the RHS and Agency enter into a 
memorandum of understanding, or other similar arrangement, under which 
the RHS agrees to notify the Agency of the inspection results.
    (4) Delegation. An Agency may delegate inspection under this 
paragraph (d) to an Authorized Delegate retained under paragraph (f) of 
this section. Such Authorized Delegate, which may include HUD or a HUD-
approved inspector, must notify the Agency of the inspection results.
    (e) Notification-of-noncompliance provision--(1) In general. Under 
the notification-of-noncompliance provisions, the Agency must be 
required to give the notice described in paragraph (e)(2) of this 
section to the owner of a low-income housing project and the notice 
described in paragraph (e)(3) of this section to the Service.
    (2) Notice to owner. The Agency must be required to provide prompt 
written notice to the owner of a low-income housing project if the 
Agency does not

[[Page 156]]

receive the certification described in paragraph (c)(1) of this section, 
or does not receive or is not permitted to inspect the tenant income 
certifications, supporting documentation, and rent records described in 
paragraph (c)(2)(ii) of this section, or discovers by inspection, 
review, or in some other manner, that the project is not in compliance 
with the provisions of section 42.
    (3) Notice to Internal Revenue Service--(i) In general. The Agency 
must be required to file Form 8823, ``Low-Income Housing Credit Agencies 
Report of Noncompliance,'' with the Service no later than 45 days after 
the end of the correction period (as described in paragraph (e)(4) of 
this section, including extensions permitted under that paragraph) and 
no earlier than the end of the correction period, whether or not the 
noncompliance or failure to certify is corrected. The Agency must 
explain on Form 8823 the nature of the noncompliance or failure to 
certify and indicate whether the owner has corrected the noncompliance 
or failure to certify. Any change in either the applicable fraction or 
eligible basis under paragraph (c)(1)(ii) and (vii) of this section, 
respectively, that results in a decrease in the qualified basis of the 
project under section 42 (c)(1)(A) is noncompliance that must be 
reported to the Service under this paragraph (e)(3). If an Agency 
reports on Form 8823 that a building is entirely out of compliance and 
will not be in compliance at any time in the future, the Agency need not 
file Form 8823 in subsequent years to report that building's 
noncompliance. If the noncompliance or failure to certify is corrected 
within 3 years after the end of the correction period, the Agency is 
required to file Form 8823 with the Service reporting the correction of 
the noncompliance or failure to certify.
    (ii) Agency retention of records. An Agency must retain records of 
noncompliance or failure to certify for 6 years beyond the Agency's 
filing of the respective Form 8823. In all other cases, the Agency must 
retain the certifications and records described in paragraph (c) of this 
section for 3 years from the end of the calendar year the Agency 
receives the certifications and records.
    (4) Correction period. The correction period shall be that period 
specified in the monitoring procedure during which an owner must supply 
any missing certifications and bring the project into compliance with 
the provisions of section 42. The correction period is not to exceed 90 
days from the date of the notice to the owner described in paragraph 
(e)(2) of this section. An Agency may extend the correction period for 
up to 6 months, but only if the Agency determines there is good cause 
for granting the extension.
    (f) Delegation of Authority--(1) Agencies permitted to delegate 
compliance monitoring functions--(i) In general. An Agency may retain an 
agent or other private contractor (``Authorized Delegate'') to perform 
compliance monitoring. The Authorized Delegate must be unrelated to the 
owner of any building that the Authorized Delegate monitors. The 
Authorized Delegate may be delegated all of the functions of the Agency, 
except for the responsibility of notifying the Service under paragraphs 
(c)(5) and (e)(3) of this section. For example, the Authorized Delegate 
may be delegated the responsibility of reviewing tenant certifications 
and documentation under paragraph (c) (1) and (2) of this section, the 
right to inspect buildings and records as described in paragraph (d) of 
this section, and the responsibility of notifying building owners of 
lack of certification or noncompliance under paragraph (e)(2) of this 
section. The Authorized Delegate must notify the Agency of any 
noncompliance or failure to certify.
    (ii) Limitations. An Agency that delegates compliance monitoring to 
an Authorized Delegate under paragraph (f)(1)(i) of this section must 
use reasonable diligence to ensure that the Authorized Delegate properly 
performs the delegated monitoring functions. Delegation by an Agency of 
compliance monitoring functions to an Authorized Delegate does not 
relieve the Agency of its obligation to notify the Service of any 
noncompliance of which the Agency becomes aware.
    (2) Agencies permitted to delegate compliance monitoring functions 
to another Agency. An Agency may delegate all or some of its compliance 
monitoring responsibilities for a building to another

[[Page 157]]

Agency within the State. This delegation may include the responsibility 
of notifying the Service under paragraph (e)(3) of this section.
    (g) Liability. Compliance with the requirements of section 42 is the 
responsibility of the owner of the building for which the credit is 
allowable. The Agency's obligation to monitor for compliance with the 
requirements of section 42 does not make the Agency liable for an 
owner's noncompliance.
    (h) Effective date. Allocation plans must comply with these 
regulations by June 30, 1993. The requirement of section 42 
(m)(1)(B)(iii) that allocation plans contain a procedure for monitoring 
for noncompliance becomes effective on January 1, 1992, and applies to 
buildings for which a low-income housing credit is, or has been, 
allowable at any time. Thus, allocation plans must comply with section 
42(m)(1)(B)(iii) prior to June 30, 1993, the effective date of these 
regulations. An allocation plan that complies with these regulations, 
with the notice of proposed rulemaking published in the Federal Register 
on December 27, 1991, or with a reasonable interpretation of section 
42(m)(1)(B)(iii) will satisfy the requirements of section 
42(m)(1)(B)(iii) for periods before June 30, 1993. Section 
42(m)(1)(B)(iii) and these regulations do not require monitoring for 
whether a building or project is in compliance with the requirements of 
section 42 prior to January 1, 1992. However, if an Agency becomes aware 
of noncompliance that occurred prior to January 1, 1992, the Agency is 
required to notify the Service of that noncompliance. In addition, the 
requirements in paragraphs (b)(3) and (c)(1)(v), (vi), and (xi) of this 
section (involving recordkeeping and annual owner certifications) and 
paragraphs (c)(2)(ii)(B), (c)(2)(iii), and (d) of this section 
(involving tenant file reviews and physical inspections of existing 
projects, and the physical inspection standard) are applicable January 
1, 2001. The requirement in paragraph (c)(2)(ii)(A) of this section 
(involving tenant file reviews and physical inspections of new projects) 
is applicable for buildings placed in service on or after January 1, 
2001. The requirements in paragraph (c)(5) of this section (involving 
Agency reporting of compliance monitoring activities to the Service) and 
paragraph (e)(3)(i) of this section (involving Agency reporting of 
corrected noncompliance or failure to certify within 3 years after the 
end of the correction period) are applicable January 14, 2000.

[T.D. 8430, 57 FR 40121, Sept. 2, 1992; 57 FR 57280, Dec. 3, 1992; 58 FR 
7748, Feb. 9, 1993; T.D. 8563, 59 FR 50163, Oct. 3, 1994; T.D. 8859, 65 
FR 2326, Jan. 14, 2000; 65 FR 16317, Mar. 28, 2000]