IRS Clarifies the Unit Vacancy Rule – Elizabeth L. Moreland, NCP-E

November 1, 2001
The IRS Chief counsel’s office has released a memo – Doc. No. 200137028 – that answers questions about a specific housing credit program requirement… the Unit Vacancy Rule. This is an internal memorandum and is not a precedent. The IRS clarified that the Unit Vacancy Rule, unlike the Next Available Unit Rule, should be applied on a project basis. As to how "reasonable attempts" should be defined, the IRS was very vague. Finally, management will be able to eliminate some of the "available" units as long as the units have a binding legal agreement.

Keywords: Unit Vacancy Rule; Next Available Unit Rule;

IRS Clarifies the Unit Vacancy Rule

Elizabeth L. Moreland, NCP-E

November 1, 2001
The IRS Chief Counsel's office has released a memo – Doc. No. 200137028 – that answers questions about a specific housing credit program requirement … the Unit Vacancy Rule.

Before summarizing this document, it is first important to explain that it is an internal memorandum and is not a precedent. Basically this document is answering questions given to the Chief Counsel by the audit division, requesting clarification on certain portions of the Unit Vacancy Rule.

In the memo, the Chief Counsel is asked to clarify three items in regards to the Unit Vacancy Rule (UVR). First, whether the UVR is applied on a building-by-building basis or a project basis; second, how "reasonable attempts" should be defined; and third, whether the legal binding agreement provision of the Available Unit Rule (AUR) applies to the UVR.

Project vs. Building … That is the Question!

The first request for clarification regarding the application of the rule has been under discussion for years. In the past, the IRS has vacillated on this issue, but with the publication of this memo, appears to have committed to viewing it as a project rule.

As per the memo:

"Under the vacant unit rule of § 1.42-5(c)(ix), vacant units formerly occupied by low-income individuals may continue to be treated as occupied by a qualified low-income individual for purposes of the set-aside requirement (as well as for determining qualified basis) provided reasonable attempts are made to rent the unit and no other units of comparable or smaller size in the project are rented to nonqualifying individuals. As stated in the legislative history, the vacant unit rule is applied on a project-wide basis, rather than on a building-by-building basis. H.R. Conf. Rep. No. 99-41, 99th. Cong. 2d Sess. II-94 (1986). Therefore, we do not apply the vacant unit rule on a building-by-building basis. Note, however, that § 42(g)(2)D(ii) specifically requires that the available unit rule be applied on a building-by-building basis."

Therefore the IRS is clarifying that indeed the Unit Vacancy Rule, unlike the Next Available Unit Rule, should be applied on a project basis.

Vague Answer Leads to Important Management Decisions

As far as the second request for clarification as to what constitutes "reasonable attempts", the answer is far more vague stating:

"What constitutes a reasonable attempt to rent a vacant unit is factual, and may differ from project to project depending on the size, location, and dollar value of the particular project. Also, the different advertising media and technologies accessible (geographically and financially) to projects would affect what is considered reasonable. Therefore, we do not define what is a reasonable attempt to rent a vacant unit."

As the IRS is unwilling or unable to define reasonable attempts, we will need to consider what "reasonable attempts" are on a case-by-case basis. The conservative action would be to rent all available Housing Credit units before any non-Housing Credit units of comparable or smaller size in the PROJECT.

However, as this may adversely affect the cash flow of the property, you will want to determine how your management operations will define "reasonable attempts" and how such attempts will be documented to prove they were indeed taken prior to renting any comparable or smaller non-Housing Credit units when there are vacant Housing Credits units in the project.

Such a decision should take into consideration the spirit of the rule itself and the market conditions of the area as well as the property itself. Management will need to have a written policy as to how they define the reasonable attempts provision has been met and be sure it is consistently applied throughout the property. Be sure to justify how this decision was made if it deviates from the conservative approach of strictly adhering to the rule. It is also strongly advised that you contact your State Monitoring Agency to determine how they are going to audit for this rule. My guess is the State Monitoring Agencies will leave the decision as to whether the reasonable attempts provision of this rule was satisfied to the IRS and will submit an 8823 on any situation where the UVR was not strictly followed, in turn, allowing you to plead your case to the IRS.

Binding Legal Agreements to the Rescue!

And lastly, the third request for clarification asking whether the legal binding agreement provision of the Available Unit Rule applies to the Unit Vacancy Rule appears to be affirmative.

As per the memo:

"The fact that a unit is subject to a reservation under local law would indicate that reasonable attempts have been made to rent the unit. Although not specifically provided, it appears appropriate to apply this reservation standard for purposes of the available unit rule to determine when a unit is considered rented under the vacant unit rule."

With this clarification, management will be able to eliminate some of the "available" units as long as the units in question having binding legal agreements or leases on them. In cases where the market rate unit is not yet physically occupied but has a binding legal agreement signed by a tenant who plans to occupy in the future, the unit will not be considered "available" if and when a Housing Credit unit becomes vacant. Taken this into consideration, management will want to sign its market rate leases or legal agreements as early as possible. Vacant Housing Credit units that have been reserved for a qualified resident through a legal agreement will be considered "rented" for purposes of the UVR, even though the new resident has not yet taken occupancy. (For additional information on binding legal agreements, see "Back to the Basics" contained in this issue.)

Also, management will want to consider when to take possession of any Housing Credit units that were occupied by households who have skipped. If management does not take possession of the unit and continues to obligate the skipped household to its legal commitment, the unit will not be determined to be available even though it is not physically occupied. The decision as to when to take possession of such units should be weighed by the likelihood of a fast re-occupancy of the unit by a qualified Housing Credit household. If it is difficult to re-rent the Housing Credit units due to market conditions or paperwork processing difficulties, management may decide not to take possession of the skipped unit as soon as another management company that has optimal marketing conditions and smoother paperwork procedures.

Owners and managers of mixed-income Housing Credit developments will need to seriously consider all three clarifications to this rule and determine how they plan to apply them at their properties. It appears that with this issuing of this memo, the IRS has finally spoken and clarified this difficult and often-frustrating rule. Even though we didn’t get the news we had hoped for and the rule will indeed be applied on a project basis, you can still make the rule if you sit down and decide how you will apply the reasonable attempts and legal binding agreement provisions.

A copy of the memo can be obtained by going to our web site – www.taxcreditlibrary.com.