The LIHTC compliance period is the 15-year stretch, beginning with the first year of the credit period, in which an owner of a Low-Income Housing Tax Credit property must keep units rent-restricted, occupied by income-qualified households, and physically sound. Fall out of compliance during those 15 years and the IRS can recapture a portion of the credits already claimed, plus interest.1Office of the Law Revision Counsel. 26 USC 42 – Low-Income Housing Credit A separate extended use commitment then continues the affordability restrictions for at least another 15 years, so the practical horizon on most deals is closer to 30.
When the 15 Years Start and What They Cover
The compliance period runs for 15 taxable years starting with the first year of the credit period.1Office of the Law Revision Counsel. 26 USC 42 – Low-Income Housing Credit The credit period itself begins the year the building is placed in service, or the following year if the owner makes an irrevocable election to delay. Credits are claimed over 10 years, but the compliance obligations continue for five years after the last credit dollar is claimed. Finishing the credit period is not the same as finishing compliance.
Throughout those 15 years, the building has to continuously satisfy the income and rent restrictions elected at the outset, keep the physical property in decent condition, and maintain tenant files that prove it. If the qualified basis drops at any point in that window, recapture is on the table.
How Recapture Works
Recapture is what gives the compliance period its bite. When a building’s qualified basis decreases during the 15-year period, the owner’s tax liability increases by the credit recapture amount.1Office of the Law Revision Counsel. 26 USC 42 – Low-Income Housing Credit Qualified basis depends on how many units remain low-income relative to the building’s eligible basis, so when units fall out of compliance, qualified basis shrinks and the recapture calculation kicks in.
The math compares credits actually claimed against a hypothetical stream of credits spread evenly across all 15 years. Because credits are front-loaded into the first 10 years, owners claim more early on than they would under a straight-line approach. The gap between the two figures is the “accelerated portion,” and that is the amount subject to recapture. On top of that, the IRS charges interest at the federal overpayment rate for every year the excess credit was claimed.1Office of the Law Revision Counsel. 26 USC 42 – Low-Income Housing Credit For a property several years into its credit stream, the interest alone can be a large number.
The Casualty Loss Carve-Out
Not every loss of qualified basis triggers recapture. When a building is damaged by fire, storm, or another sudden event, recapture does not apply so long as the owner restores the lost qualified basis within a reasonable period. IRS guidance treats up to two years following the end of the tax year in which the loss occurred as consistent with general replacement principles.2Internal Revenue Service. IRC 42 Low-Income Housing Credit – Part VII Computing Adjustments The owner cannot claim credits on the affected units while restoration is underway. Damage from gradual deterioration, such as termite infestation or deferred maintenance, does not qualify for this relief.
The Minimum Set-Aside You’re Locked Into
Every LIHTC property must meet one of three minimum occupancy tests to qualify as a low-income project. The owner elects which test applies, and that election is permanent.
- 20-50 test: at least 20 percent of the residential units are rent-restricted and occupied by tenants with incomes at or below 50 percent of area median gross income.
- 40-60 test: at least 40 percent of the residential units are rent-restricted and occupied by tenants with incomes at or below 60 percent of area median gross income.
- Average income test: at least 40 percent of the residential units are rent-restricted and occupied by tenants whose incomes do not exceed individually designated limits, provided the average of those designations does not exceed 60 percent of area median gross income.1Office of the Law Revision Counsel. 26 USC 42 – Low-Income Housing Credit
Under the average income test, each unit can be designated at 20, 30, 40, 50, 60, 70, or 80 percent of area median income, so long as the overall average stays at or below 60 percent.1Office of the Law Revision Counsel. 26 USC 42 – Low-Income Housing Credit Designations cannot be changed retroactively after the tax year closes, and occupied units cannot have their designation changed even if the tenant’s income would support a lower limit. Failing the elected minimum set-aside is one of the ways to lose the project’s low-income status entirely.
The Day-to-Day Compliance Traps
Most recapture risk during the 15 years comes from ordinary property operations rather than dramatic events. A handful of rules do most of the damage.
Rents and Utility Allowances
Maximum rents are tied to the income limits for the project and vary by unit size. HUD estimates median family income annually for each metropolitan area and non-metropolitan county, and those figures drive the rent ceilings.3HUD USER. Income Limits Rents for larger units assume an additional 1.5 persons per bedroom, so a two-bedroom ceiling is higher than a one-bedroom in the same project. The rent limit is a gross figure that includes an allowance for tenant-paid utilities.
If tenants pay any utilities directly, the maximum rent the owner can charge must be reduced by the applicable utility allowance. Federal regulations approve several methods for calculating that allowance, and the choice affects revenue. The common option is the local Public Housing Authority schedule for Section 8. Owners can also obtain a written estimate from the local utility company for a similarly sized unit, request an estimate from the state housing agency, use HUD’s Utility Schedule Model, or hire a licensed engineer to build an energy consumption model for the property.4eCFR. 26 CFR 1.42-10 – Utility Allowances Whichever method is used, the owner must review the allowance at least once per calendar year and update it as needed. Miscalculate the allowance and charge rent above the gross ceiling and every affected unit is out of compliance.
The Next Available Unit Rule
Tenants who qualified at move-in sometimes see their incomes rise. A low-income unit becomes an “over-income unit” when the household’s aggregate income exceeds 140 percent of the applicable income limit.5eCFR. 26 CFR 1.42-15 – Available Unit Rule The existing tenant does not have to leave, but the owner must rent the next available comparable unit (same size or smaller) in that building to a qualified low-income household.
If the owner instead leases that next available comparable unit to someone who does not qualify, every over-income unit in the building for which the rented unit was comparable loses its low-income status.5eCFR. 26 CFR 1.42-15 – Available Unit Rule A single bad leasing decision can knock multiple units out of compliance and pull qualified basis down. The rule is applied building by building, so multi-building projects have to track each structure separately.
Full-Time Student Households
A household composed entirely of full-time students generally cannot occupy a low-income unit. A single full-time student living with non-student household members is fine. A unit where every occupant is a full-time student is disqualified unless the household fits one of five federal exceptions: married couples filing jointly; single parents with minor children who are not dependents of another person; households where a member receives certain government assistance under Title IV of the Social Security Act; households where a member was previously in foster care; and households where a member is enrolled in a government-funded job training program.
Each exception requires third-party documentation at move-in, and student status must be verified annually. Properties near college campuses need particularly careful screening, because a household that qualified at move-in can lose eligibility mid-lease if the members enroll full-time.
How State Agencies Catch Problems
State housing agencies monitor compliance under Treasury regulations. They must conduct on-site inspections and review low-income certifications for every project by the end of the second calendar year after the last building is placed in service, and at least once every three years after that.6eCFR. 26 CFR 1.42-5 – Monitoring Compliance With Low-Income Housing Credit Requirements Inspections cover the physical condition of the buildings; file reviews check tenant certifications, rent records, and supporting documentation.
Owners also verify tenant income and household composition annually through the Tenant Income Certification process. For properties where 100 percent of units receive tax credits, federal law permits an exemption from annual recertification after the first year, though most state agencies continue to require it anyway.
Form 8823 and the Correction Window
When an agency identifies noncompliance, it reports the issue to the IRS on Form 8823. The form covers the full range of violations: incomes exceeding limits at initial occupancy, missing annual recertifications, physical condition problems, rent overcharges, minimum set-aside failures, next available unit rule violations, student eligibility problems, and utility allowance miscalculations, among others.7Internal Revenue Service. Form 8823 – Low-Income Housing Credit Agencies Report of Noncompliance or Building Disposition
A Form 8823 filing does not automatically mean credits are lost. The form distinguishes noncompliance corrected within the applicable correction period from noncompliance that remains uncorrected. If the owner fixes the issue in time, the agency reports both the violation and the correction. If not, the form goes to the IRS marked uncorrected, and the case is evaluated for possible audit. The IRS reviews the three most recent tax returns and all Form 8823 filings for the project before deciding whether to send it for examination.8Internal Revenue Service. Exhibit 1-1 Reports of Noncompliance (Form 8823) Process Map and Explanations Correcting quickly is often the difference between a paperwork event and a recapture event.
Year 15 Is Not the End
The compliance period closes at year 15, but the affordability restrictions typically do not. For any building receiving credits allocated after 1989, the owner had to enter into an extended low-income housing commitment before credits could be claimed at all.9Congress.gov. Omnibus Budget Reconciliation Act of 1989 – Summary That agreement must last at least 15 years beyond the close of the 15-year compliance period, taking the minimum total commitment to roughly 30 years.1Office of the Law Revision Counsel. 26 USC 42 – Low-Income Housing Credit Many state agencies impose even longer terms as a condition of receiving a credit allocation.
The extended use commitment is recorded against the property as a restrictive covenant under state law, so it binds future owners. Current and former tenants who meet the income requirements have a private right to enforce the restrictions in state court, and the agreement also has to prohibit the owner from refusing to lease to a household solely because they hold a Section 8 voucher. Federal credit recapture generally expires when the 15-year compliance period ends, but violations of the extended use agreement during the years that follow can still affect an owner’s eligibility for future allocations and other affordable housing programs, and state agencies enforce the land use restriction agreement during that phase.