Arkansas Administrative Code
Agency 109 - Arkansas Development Finance Authority
Division 04 - Multi-Family Housing
Rule 109.04.07-001 - Compliance Monitoring Policies and Procedures Manual for the Low Income Housing Tax Credit (LIHTC) Program

The Arkansas Development Finance Authority ("ADFA" or the "Authority"), a public body politic and corporate, with corporate succession, was created May 1, 1985 by Act 1062. This act abolished the former Arkansas Housing Development Agency that had existed since 1977. The former agency had as its sole purpose to sell tax-exempt bonds and use the proceeds to develop safe, decent, sanitary and affordable housing for low and moderate income Arkansans. All records, funds, properties, obligations, debts, functions, powers and duties were transferred to ADFA, which sells both taxable and non-taxable bonds and supports programs not only for housing but also for economic development, agriculture, aquaculture, export finance, government finance, and tourism development.

This Policies and Procedures Manual presents an overview of ADFA's policies as they pertain to compliance monitoring for the Low Income Housing Tax Credit ("LIHTC") Program. The procedures are designed to assist owners and managers of developments that have received an allocation pursuant to the LIHTC Program to ensure that the developments remain in compliance with Section 42 of the Internal Revenue Code ("the Code"). The procedures are not intended to be all-inclusive. In the event of a conflict or inaccuracy, the Code will control. If the development has received a combination of funds from other government entities, owners must follow the most restrictive regulations. For instance, an owner may have received funds under a governmental program in which he agreed to rent a certain number of units to persons earning 40% or less of the area median income. The owner must be sure to satisfy this restriction in addition to the applicable LIHTC area median income limit. Employees and officers of ADFA are not liable for any adverse consequences that affect the taxpayer or investor relative to compliance with the federal tax code. ADFA reserves the right to implement additional policies as needed. Also, new rulings or other changes may be made periodically. Owners are responsible for compliance with any amendments or updates to the federal regulations.

Any questions regarding this Manual should be directed to:

Compliance Monitoring Department Arkansas Development Finance Authority P. O. Box 8023 Little Rock, AR 72203-8023 Telephone: (501) 682-5900 Telecopy: (501) 682-5859

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Congress created the LIHTC Program under the Tax Reform Act of 1986. The LIHTC Program, governed by Section 42 of the Internal Revenue Code, began in 1987. The tax credit is a dollar-for-dollar reduction in tax liability to investors in exchange for equity participation in the construction or acquisition and rehabilitation of rental housing that will remain income and rent restricted for an extended period of time. Tax credits are allocated by ADFA for properties located in Arkansas. After ADFA allocates the tax credits to developers, the developers typically sell the credits to private investors. The private investors use the tax credits to offset taxes otherwise owed on their tax returns. The money private investors pay for the credits is paid into the projects as equity financing. Equity financing is used to fill the gap between development costs for a project and the non-tax credit financing sources, such as mortgages, that could be expected to be repaid from rental income. In awarding the credits, ADFA attempts to provide sufficient credits to ensure the project's financial feasibility throughout the 15-year tax credit compliance period. ADFA must consider any proceeds or receipts expected to be generated through tax benefits, the percentage of housing credit dollar amounts used for project costs other than the cost of intermediaries, and the reasonableness of developmental and operational costs. Generally, ADFA will compare the proposed project's developmental costs with the nontax credit financing, both private and governmental. The difference between the development costs and the nontax credit financing is the financing gap. Tax credits are used to attract the equity investment needed to fill the gap, but are limited to a ceiling. Under Section 42 of the Code, the ceiling on tax credits limits the present value of the 10-year stream of tax benefits to:

Generally, owners must place the projects in service within two (2) years of carryover allocation or return the credits to ADFA for reallocation to other projects. Once a development is placed in service, it is generally eligible for the tax credit every year for ten (10) years. To continue generating the credit and avoid recapture, an LIHTC building must satisfy specific tax credit compliance rules for fifteen (15) years. In cases where 100% low-income occupancy is not achieved during the first tax credit year, (for example, either due to unqualified tenants or inability to find qualified tenants to qualify units) there will be possible increases in qualified basis in subsequent years. In such cases, excess qualified basis shall have the percentage equal to 2/3 of the applicable fraction applied, thus extending the tax credits claimed over the 15-year compliance period. The tax credits may be generated annually on a building-by-building basis beginning either with the taxable year in which the building is placed in service or, at the election of the taxpayer (owner), the succeeding taxable year.

For buildings placed in service in 1987, the credit was taken at annual rates of 9 percent (for the 70 percent value credit) and 4 percent (for the 30 percent value credit). Three types of credit are available for low-income buildings placed in service after 1987. The first type of credit is a 9 percent annual credit for the cost of a new building or qualifying rehabilitation costs, without a federal subsidy. The second type of credit is a 4 percent annual credit for the cost of a new building or substantial rehabilitation built with a federal subsidy. The third type of credit is a 4 percent annual credit for the cost of buying an existing building for which substantial rehabilitation expenditures are also incurred. Although the 9 percent and 4 percent credits are called 9 percent and 4 percent, the figures are actually estimates. The IRS sets the figures each month based upon fluctuating interest rates. A project can qualify for one of the three credits or a combination of the credits.

Low income housing tax credit amounts are based on the cost of a building and the portion of the project that low-income households occupy. The cost of acquiring, rehabilitating, and constructing a building constitutes the building's eligible basis. The portion of the eligible basis attributable to low-income units is the building's qualified basis. Generally, the qualified basis excludes the cost of land. Developers are urged to consult legal counsel, as other costs may be excluded.

Low-income housing tax credit projects that use federal subsidies generally receive a smaller credit. If federally subsidized loans are used to finance substantial rehabilitation or new construction, either the eligible basis of the building must be reduced or the 30% credit must be used. Federally subsidized loans include below-market federal loans and tax-exempt financing.

The compliance period for any building is the period beginning on the first day of the first taxable year of the credit period of such building and ending fifteen (15) years from such date. Beginning in 1990, ADFA implemented the Land Use Restriction Agreement ("LURA"), which extended the compliance period for an additional fifteen-year period. The LURA, recorded in the real estate records of the county in which the development is located, is a binding agreement of the owner and any successors to maintain specific occupancy and affordability requirements for the development.

Projects placed in service before the use of the LURA (1987, 1988, 1989,) must comply with the initial 15-year compliance period only. In reference to those projects, ADFA will review the IRS form 8609 to determine the year the owner claimed the tax credits. If there is no completed copy of the IRS form 8609 available, ADFA staff will ask the project owner to confirm the credit year. Upon determining that the 15-year compliance period has

expired, ADFA will notify the owner that the compliance period has ended and that ADFA will no longer conduct physical or tenant file audits.

After the initial 15-year compliance period, ADFA will continue to monitor developments with extended use agreements. ADFA intends to enforce the terms and agreements set forth in the Land Use Restriction Agreement and Declaration of Restrictive Covenants for the Low Income Housing Tax Credits ("LURA") and ADFA's Compliance Monitoring Policies and Procedures Manual for the LIHTC Program. ADFA will not modify any of the Section 42 requirements. Owners will be allowed specific time periods, as deemed appropriate by ADFA, to correct items of noncompliance.

Remedies for noncompliance include, but are not limited to, the following:

* Temporary suspension or permanent expulsion from participation in the LIHTC, HOME, or any other program administered by ADFA;

* Notification to other lenders or agencies that provided funding for the project;

* Notification to the limited partners, syndicators, board of trustees, or any other affiliate of the project; and

* Legal action.

Since the 1986 enactment of the LIHTC, Congress has changed or amended the laws governing the program, yet many changes have not been retroactive. In some cases, the change in regulations brought forth by a technical correction is minor; in others, the effect is substantial. Owners must be aware of the differences in regulations and which credit period applies to each building or development. The period considered for management/compliance purposes is the year in which tax credits were allocated by ADFA. Currently, there are four (4) specific credit regulation periods as follows:

Two important revenue rulings were later issued that were not retroactive.

September 9, 1992 IRS Revenue Ruling 92-61 deals with treatment of staff units as part of the eligible basis.

September 26, 1997 Section1.42-15 Available Unit Rule was adopted as an amendment to the regulations. This rule allows over-income persons in LIHTC units to relocate to another unit in the same building.

Compliance with the requirements of the Code is the development owner's responsibility. ADFA's obligation to monitor the development for compliance does not make ADFA liable for an owner's non-compliance, nor does it alleviate an owner's duty to comply with applicable Code requirements. In Compliance with Section 42 of the Code and in accordance with ADFA's Compliance Monitoring Policies and Procedures Manual for the LIHTC Program, the owner, by accepting the allocation of low-income housing tax credits, is obligated to:

Fundamental requirements include the following:

ADFA recommends that each development owner or manager maintain an "Administrative File/Binder for ADFA LIHTC Record Keeping Procedures " Since the information will be reviewed by ADFA during each visit, the Administrative File/Binder must include, but is not limited to the following items:

* Completed 8609 forms on each building with building identification numbers (signed by ADFA, Part II completed and signed by the development owner);

* Records that indicate the character and use of any nonresidential portion of the development included in eligible basis as defined under Section 42(d). For example, tenant facilities that are available on a comparable basis to all tenants for which no separate fee is charged for the use of the facilities or facilities reasonably required by the development;

* Certificates of Occupancy or Approval;

* The eligible basis and qualified basis of the building at the end of the first year of the credit period;

* Copy of Land Use Restriction Agreement ("LURA") or other extended use agreement;

* The vacancy history of the low income units and when and to whom the next available unit was rented;

* Total number of units in the property (this information must be retained on a building-by-building basis including the number of bedrooms and the square footage of each unit);

* HUD income tables for all years the development has been placed in service;

* Household size;

* Rents charged on each type of unit, including applicable utility allowances for all years the development has been placed in service;

* Non-residential use fee (i.e. additional fees charged for parking, etc.);

* 20/50 Test, Section 42 of the Code, OR 40/60 Test, Section 42 of the Code (also known as the minimum set-aside);

* Partnership Agreement;

* Management Agreement;

* Evidence of Fair Housing Compliance;

* Copies of reports submitted to ADFA (such as annual occupancy status reports); and

* Change in Ownership documentation, if applicable

First year records (including the tenant file for each tenant that initially occupied the LIHTC units, rent rolls, etc.) provide evidence that the property met its minimum set-aside, targeted applicable fraction, and other elected set-asides. Such first year records must be kept for twenty-one (21) years and subsequent records must be kept for a minimum of six (6) years, as mandated under the Code. ADFA requires the owner to certify on the Owner's Certificate of Continuing Program Compliance that he is complying with this section of the Code.

During the on-site visit, ADFA's staff, in addition to interviewing tenants, will check the following:

ADFA requires files to be maintained in a consistent order. ADFA's staff will randomly select and review at least 20% of current tenant files, as required by IRS. First year tenant files must also be available on site for review. ADFA staff will conduct a thorough examination to:

ADFA's staff will conduct inspections of the units that are randomly selected for file audit and will utilize Uniform Physical Conditions Standards and/ or ADFA-approved design standards. Owners may utilize standardized inspection forms for quarterly unit inspections. ADFA staff will inspect major areas of the property, identify the defect and the severity level of the defect. The levels are 1, 2, and 3 with 3 being the most severe. Any life threatening hazard must be addressed immediately. UPCS identifies the following inspectable areas:

ADFA currently assesses a one-time monitoring fee equal to 6% of the total annual housing credits allocation required at the time the owner submits the final development cost certification and requests issuance of IRS form 8609(s). This upfront monitoring fee covers the expense of the initial 15-year compliance period.

Effective January 1, 2008, ADFA will begin to collect annual monitoring fees of $50.00 per low-income housing credit unit. The additional fees will only be assessed to properties in the 16th (or later) year of compliance and will run through the 30th (or final) year of compliance. The annual amount is due and payable no later than February 1st of each year.

Each year, the check must be attached to the annual Owner's Certificate of Continuing Program Compliance. The annual fees terminate with the termination of the LURA. Thus, the 6% monitoring fee that is paid before the issuance of Form 8609 covers the first 15 years. During years 16 - 30 (or longer) of the extended period, owner will pay an annual monitoring fee of $50.00 per low income tax credit unit. This collection begins January 1, 2008.

In order for an owner to claim tax credits, a development must have a minimum number of qualified tax credit units. The owner must select one of two minimum set- asides, which establishes both the minimum percentage of tax credit units at the development and the maximum income limit used to determine tenant eligibility.

The choices are 20/50 and 40/60. Under the 20/50 selection, 20% or more of the aggregate residential rental units in the development must be occupied by persons with incomes of 50% or less of the area median gross income adjusted for family size. Under the 40/60 selection, 40% or more of the aggregate residential units in the development must be occupied by individuals with incomes of 60% or less of the area median gross income adjusted for family size.

The owner selects the minimum set-aside when applying for the tax credit allocation and makes the election on Form 8609. Once selected, the minimum set-aside is irrevocable. The year tax credits are "claimed" determines when the minimum set-aside test must be met. The minimum set-aside test must be maintained for the entire compliance period. If the property is identified as a multiple building project on Line 8b of Form 8609, the minimum set-aside may be met across the development. If the property is not identified as such, the minimum set-aside must be met building-by-building. For 1987-1990 developments, the minimum set-aside had to be met within twelve (12) months of the placed-in-service date. For 1991 and later years, the minimum set-aside must be met no later than December 31 of the second year of the initial credit period. The minimum set-aside must be met before any credits may be claimed.

The federal minimum set-aside election must not be confused with other set-aside elections that may have earned extra points in the allocation process and are recorded in the development's Regulatory Agreement. Additionally, the tax credit set-aside must not be confused with HOME fund requirements or subsidy programs such as Section 8 or Rural Development. Owners must always determine the tax credit minimum set-aside first and review allocation documents to identify any additional set-asides. If the development has layers of funding, the owner must follow the most restrictive set-aside requirements.

The Department of Housing and Urban Development (HUD) publishes the Section 8 area median gross income (AMGI) limits annually. The IRS requires these income limits, adjusted for family size, to be used when determining eligibility of LIHTC tenants at move-in. The minimum set-aside election establishes whether the 50% or 60% AMGI limit applies to the development 's tax credit units.

HUD's L50 Very Low Income amounts equal the 50% AMGI limits for households of one to eight persons. The 60% AMGI limit must be calculated from the 50% limits. The 60% AMGI limit equals 120% of the HUD Very Low-Income amount for the corresponding family size. Owners must calculate the 60% limits by multiplying the 50% AMGI figures by 1.2.

When HUD publishes new income limits, owners are required to implement the new income limits no later than 45 days after the effective date. Any fluctuations in the income limits will have a corresponding impact on maximum gross rent amounts. When determining income levels for qualifying tenants, the correct family size must be determined. A family includes all occupants of the unit. Owners should closely monitor family size.

Note: Owners and managers must review development files to determine if HUD or Rural Development restrictions also apply or if owner agreed to other income restrictions.

Units qualifying for tax credits are subject to a rent restriction formula that sets the maximum gross rent that may be charged. The maximum gross rent (including utilities) may not exceed 30% of the imputed income limitation. If low-income tenants are charged more than the allowable rent, the unit is in non-compliance and recapture of credits may result. Whenever utility costs are paid directly by the tenant, gross rent must include an allowance for utilities. Telephone and cable are not considered to be essential utilities and are not included in the allowance for utilities. See page 21 for a discussion of telephones.

Maximum Gross Rent = (Applicable Income Limit x 30%) divided by 12. Remember that the tenant's rent plus the utility allowance cannot exceed the maximum gross rent.

If the rent calculation ends with an amount beyond the decimal point, you must not round the amount up. Rounding up would charge more than the maximum allowable rent, thus resulting in non-compliance.

Example: If the applicable income limit is $21,750, multiply by .30 to get $$6,525.00, and then divide by 12 to get $543.75. You may round this amount down to $543.00 but you cannot round up to $544.00. The maximum gross rent including the utility allowance cannot exceed $543.75.

1987-1989 Developments

For developments with 1987, 1988, or 1989 tax credit allocations, the unit rent is calculated using the income limit for the actual number of people in the household. Thus, the maximum rent can increase or decrease based on respective changes in the household composition.

The resulting maximum allowable rents (including utility allowance) based on household size equals (limit x 30%) ÷ 12:

The rent decreases based on a reduction in household composition or a decrease in the income limits.

1990+ Developments

For developments with 1990 and subsequent allocations, the rent formula uses an imputed family size of 1.5 persons per bedroom to determine the applicable income limit to be used for rent calculations. For efficiency or studio units, the 1-person income limit is used.

To determine which income limit is used for the bedroom size rent formula, use the imputed household size of 1.5 persons times actual number of bedrooms.

Studio - 1 person

1 BR - 1.5 persons

2 BR - 3 persons

3 BR - 4.5 persons

For the 1.5 person income limit, take the 1-person limit, add to the 2-person limit and divide by 2. Multiply your answer by 30% and divide by 12 to arrive at maximum rent.

2 bedrooms: 1.5 x 2 = 3. Use the income for 3 persons x 30% divided by 12 = maximum rent.

3 bedrooms: 1.5 x 3 = 4.50, which means that you take the income limit for 4 persons and add to the income limit for 5 persons, divide by 2. Multiply by 30% and divide by 12 = maximum rent.

4 bedrooms: 1.5 x 4 = 6. Use the income limit for 6 persons x 30% divided by 12 = maximum rent.

Income Limits Sample

Maximum Rents Sample

Owners/managers must be careful that gross rents do not exceed tax credit limits. A common mistake is to charge additional fees that are prohibited under the program. Prohibited fees include, but are not limited, to the following:

* Unit preparation fees

* Re-decorating fees

* Re-keying fees

Gross rent does not include any housing assistance payments made to an owner to subsidize a tenant's rent (i.e. Section 8). Only the actual rent paid by the tenant, including tenant-paid utilities, is counted toward the maximum allowable rent. For example, if the LIHTC maximum gross rent is $350.00 and the total tenant payment is $250.00 with Rental Assistance paying an additional $150.00 subsidy to equal the Contract Rent of $400.00, there is no problem. The amount paid by the tenant, including utilities, does not exceed $350.00.

Under the HUD Section 8 Program, a tenant cannot pay more than 30% of his adjusted gross income for rent. For this reason, in 1989 the IRS ruled that if the tenant portion of rent increases above the LIHTC maximum allowable rent, thereby reducing the Section 8 subsidy,

the higher rent may be charged. Owners must make sure the total tenant payment does not exceed the maximum LIHTC rent at time of move-in.

In RD 515 Projects, overage rents may result when 30% of the tenant income minus the utility allowance exceeds the RD Program's Basic Rent. If this overage rent exceeds the LIHTC rent, then the overage cannot always be charged. For 1991 and later year developments, the overage can be charged for amounts that are turned over to RD. In 1987-1990 developments, the overage cannot be charged to the tenant since the provision is not retroactive.

Utilities include the costs for heat, lights, air conditioning, water, sewer, and trash removal. Generally, telephone and cable are not included in utilities; however, if a supportive service or any other charge is mandatory, such charge becomes part of the gross rent calculation. This may include parking fees, a telephone if it is required to open the door for visitors, meal service, or other required costs. Whenever a tenant directly pays utility costs, a utility allowance must be used to determine the maximum unit rent that may be charged. The utility allowance must be subtracted from the maximum gross rent to determine the maximum tenant portion of rent. Utilities are part of rent. Overcharging rent can take the unit out of compliance even if the excessive amount is returned to the tenant.

Owners must calculate utility allowances based on one of the following:

If a low-income unit becomes vacant during the year, the unit remains in compliance with LIHTC regulations and eligible for the tax credit. The unit may be counted in the set-aside requirement and in determining the qualified basis provided the owner has made reasonable attempts to rent the unit or the next available comparable or smaller size unit to an eligible household and no other comparable or smaller size units in the building are rented to nonqualifying individuals.

Units that have never been occupied are termed "empty", rather than vacant, and cannot be counted as low-income units. Empty units must be included in the building's total unit count for purposes of counting the applicable fraction.

Throughout the compliance period, owners are required to keep records for each qualified low-income development showing the low-income unit vacancies and data for when, and to whom the next available units were rented. The vacant unit rule applies to both 100% LIHTC developments and mixed income developments.

If the household income for residents in a qualified unit increases to more than 140% of the current applicable income limit, the unit is considered an "over-income-unit" but may continue to be counted as an LIHTC unit as long as two conditions are met. The unit must continue to be rent restricted and the next comparable size unit in the building must be rented to a qualified low-income tenant. The owner of an LIHTC building must rent to qualified residents all comparable units that are available or that subsequently become available in the same building until the applicable fraction (excluding the over-income units) is restored to the percentage on which the credit is based. Once the original applicable fraction of the building has been restored, the "over-income" unit may remain rent restricted or may become a market-rate unit if the building is a mixed income building.

If existing LIHTC tenants wish to transfer to a different LIHTC unit in the same building (as identified by the building identification number), they do not need to be recertified. A new lease must be executed to be effective on the move-in date to the new unit. If existing LIHTC tenants wish to transfer to a unit in another building (as identified by the building identification number) the tenants must be treated exactly as prospective tenants moving in for the first time and all application, certification, and verification procedures must be completed for the household. A previously qualified tenant whose income now exceeds the

applicable income limit may relocate to another low-income unit within the same building. A tenant whose income now exceeds the applicable limit would not be eligible to move to a tax credit unit in another building. Any LIHTC tenant who moves to another building must be re-qualified and certified as an eligible tenant.

During the initial credit period, existing tenants cannot be relocated for the purpose of qualifying more than one LIHTC unit to count toward the minimum set-aside or applicable fraction.

Revenue Ruling 92-61 [Section A], effective 9/9/92, allows a unit for a full-time staff member to be considered part of a development's "common area". Such units are not classified as residential rental units and thus are not included in either the numerator or denominator of the applicable fraction under section 42(c)(1)(B) for purposes of determining the building's qualified basis.

Two options apply:

All residential rental units in the development must be available for use by the general public. LIHTC properties are subject to Title VIII of the Civil Rights Act of 1968, also known as the Fair Housing Act. This Act prohibits discrimination in the sale, rental, and financing of dwellings based on race or color, religion, sex, national origin, familial status (including children under the age of 18 living with parents or legal custodians, pregnant women and people securing custody of children under 18) and disability. However, all households must be eligible in the areas of income, occupancy, selection criteria by management, and type of property.

Tax credit units may not be provided only for members of a social organization or provided by an employer for its employees. Also, a residential unit is not for use of the general public, and therefore, does not qualify under the Code as part of a hospital, nursing home, sanitarium, life care facility, dormitory, trailer park, retirement home that provides significant services other than housing, or intermediate care facility for the disabled.

The Fair Housing Act also mandates specific design and construction requirements for multi-family housing built after March 13, 1991, to provide accessible housing for individuals with disabilities. Owners are expected to be familiar with accessibility requirements for their developments in compliance with the Fair Housing Act, Section 504 of the Rehabilitation Act of 1973, as amended, and Americans with Disabilities Act ("ADA"). Some of those pertinent facts are:

Owners may not refuse to rent to Section 8 housing choice voucher holders simply because they have Section 8. On the other hand, owners must not assume a Section 8 certificate or voucher holder automatically qualifies. Applicants eligible for Section 8 may have incomes exceeding LIHTC income limits, may have negative references, or otherwise may not qualify. Proof of income eligibility must be in the tenant file.

A unit must be suitable for occupancy in accordance with state or local codes in order for credits to be claimed. If the unit is not habitable, no credits can be claimed. The IRS has ruled that if a unit is destroyed due to a casualty loss (i.e. fire, flood, or other disaster), credits cannot be claimed while the unit is being replaced. If the unit is restored within a reasonable time, credits can again be claimed and no recapture would occur. What is a reasonable replacement time? The reasonableness of the time period to repair damaged property depends on the extent of the damage. ADFA will consider other factors such as the location of the property and the time of the year. Generally, however, two years should be sufficient for the replacement of property completely destroyed by a casualty loss. In the event the owner is not able to replace the property within two years, ADFA may extend the time period if the owner demonstrates that there is a reasonable cause for delay.

The Code specifies that LIHTC housing must be for the use of the general public on a non-transient basis. Further, the regulations state, "no dormitory... may be a qualified low income project". An LIHTC development cannot be entirely occupied by full time students. Student status becomes an issue when everyone in the household is a full-time student.

The tenant, in order to be considered a full-time student, must be (a) taking at least twelve (12) credit hours per semester; (b) taking the school's full-time requirement (as defined by the institution); or (c) enrolled five (5) months out of 12 months in an institution of higher learning. The 5 months need not be consecutive. Student status must be re-verified at annual recertifications to confirm continuing eligibility of the household. If owner has obtained a recertification waiver, he, too, must continue to check student status annually. Student status must be verified through the registrar's office of the educational institution. Children in grades K-12 are considered full-time students.

Single full-time students who are not entitled to file a joint tax return are not eligible for the tax credit unit. There is no grandfathering of eligibility because the tenant was not a student when he/she moved in and later became one.

Exceptions: A unit would not be disqualified for tax credits if it is occupied as specified in Section 42(i)(3)(D)-

Section 42 of the Code mandates that HUD Section 8 income limits adjusted for household size be used in determining income eligibility for the LIHTC program. A household can consist of one or more persons. Members need not be related to be considered a household. Count all household members and compare to the per person 50% or 60% income limits currently in effect. Please do not confuse the 140% Rule which allows an existing tenant's income to exceed the allowable limit. Owners or managers must never allow over-income applicants to move into an LIHTC unit. Full-time students residing together in a unit must qualify under one of the exceptions previously listed herein.

Certain individuals are not considered members of the household in determining the income limits. Do NOT count the income of the following when determining household income:

Temporarily absent members of the household should be counted when determining household size. Count the following:

Total income is gross income with no adjustments or deductions. 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. Annual income is the anticipated total income from all sources received by the family head and spouse (even if temporarily absent) and by each additional member of the family, including all net income derived from assets for the 12-month period following the effective date of certification of income. Certain types of income are excluded.

The LIHTC Program refers to the current HUD Handbook 4350.3 in utilizing its definition of income only. Keep in mind that the LIHTC program is governed by Section 42 of the Internal Revenue Code. Owners or managers of mixed-use properties must comply with all applicable program regulations. Allowances used in some government programs, such as childcare, elderly status, medical expense, etc., are not deducted from the household's gross annual income to determine income eligibility for LIHTC units. Owners must review the current version of the HUD Handbook 4350.3 for a comprehensive discussion of income calculations.

Annual income includes :

Tuition includes whatever the school declares as tuition. Do not add any amounts for books, fees, or other expenses that may be itemized separately on the verification form. NOTE: if you have a Section 8/Section 42 combination on the property, the student must qualify under both programs to get the benefits of both programs. If family members are students and qualify for Section 8 but the entire household consists of full-time students and none of the Section 42 exceptions apply, tax credits cannot be claimed on the affected units.

Some Common Income Exclusions are listed below. Please refer to the current HUD Handbook 4350.3 for a comprehensive list.

The net income from assets must be considered when determining the tax credit eligibility of a household. Asset information for all household members (including minors) should be obtained at the time of application. Please refer to the latest revision of HUD Handbook 4350.3 for a discussion of assets.

For LIHTC Program purposes, third party verification of assets is required only if assets exceed $5,000.00 per household. ADFA will accept the "Under $5,000 Asset Certification" included herein as Exhibit N for tax credit units only. Under the HOME or other federal programs, all assets, regardless of value, must be documented by third party verification. For example, if a tax credit unit is also HOME-assisted, the owner must comply with the stricter HOME verification requirement.

The "Under $5,000 Asset Certification" must be completed accurately. There should be no blank lines. Owners or managers should always question the reasonableness and compare the amounts on the form to the application.

If net family assets total $5,000 or less, owners must count the actual income derived from net family assets. If net family assets exceed $5,000, owners must impute the asset income by multiplying the net family assets amount by the passbook rate specified by HUD, which is currently 2 percent (.02). The income to be included in household income will be the greater of (a) actual asset income, or (b) the imputed income from assets.

At each certification and re-certification, applicants and tenants must declare whether or not an asset has been disposed of for less than fair market value during the two years preceding the date of application or the effective date of the re-certification. An asset is considered to be disposed of for less than fair market value if the cash value of the disposed asset exceeds the gross amount the family received by more than $1,000.00. If it does, for a period of two years owners must include in the total household assets the difference between the cash value of the asset and the amount received. For examples of assets disposed of for less than fair market value, you should refer to the latest revision of HUD Handbook 4350.3.

Because the LIHTC program uses special definitions for income, assets, and household composition, standard property management application forms may not collect sufficient information to determine tenant eligibility. A comprehensive housing application is critical to the accurate identification of full-time students, all assets, and anticipated income sources. An updated sample application form is included in this manual as Exhibit E.

Owners or managers must review all information furnished on the fully completed Application for Housing, including any supplementary historical documents (i.e. most recent 1040 tax form, divorce decree, etc.). The application procedure must include an interview with all adult household members to review the application and historical documents and clarify any discrepancies or missing information. For example, if the 1040 form and W-2 forms show two employers but the application only lists one, owners must ask about the second job and confirm its termination. One application signed by all co-applicants should be submitted per household. Non-related roommates should submit separate applications. If a delay of 90 days occurs between application and move-in, the owner or manager should take another application.

Owners/site managers must remember that the HUD Handbook 4350.3 is the reference guide to be used for identifying income to be included or excluded when determining household income. Determination of annual income of individuals and area median gross income must be made in a manner consistent with HUD Section 8 income definitions and guidelines.

The earned income of every prospective household member aged 18 or older must be verified. Unearned income, assets and asset income of all household members, including minors, must be verified. Verifications must be received by the owner or site manager prior to the execution of the certification of tenant eligibility and lease.

Third party verifications are valid for 120 days from date completed by employer. Owners may not rely on verifications that are more than 120 days old. After this time, a new written verification must be obtained.

Written third party verifications are preferred. An authorization to release information must be signed by the applicant and must accompany verification requests. Owners must send verifications directly to the source and the source must return them directly to the owner. Verifications must not be hand-carried by the applicant to or from the source. The owner may obtain acceptable third party written verifications by facsimile, e-mail, or Internet. If written verification is not possible, direct contact with the source, in person or by telephone, is acceptable. The owner must document this verbal verification in the tenant file and must obtain all information as requested on the written verification form.

The waiting list is required as part of the selection process. No one should be placed on the waiting list unless he has submitted a completed application. All applications should be logged by date and time received. The waiting list should have columns for bedroom size, need for subsidy (if available), any other program priorities, need for accommodations for disabled persons, gross income, etc. If the owner has more than one income level in the LIHTC property, the owner must keep appropriate lists or columns by 30%, 50%, 60%, or other income limit.

All tenants occupying tax credit units must be certified and under lease no later than the date the tenant takes possession of the unit. All parties must sign the lease by the beginning of the lease term date to be properly in effect and the unit in compliance.

Some leasing guidelines are as follows:

Section 42 of the Code requires that recertification of residents be completed on at least an annual basis. Annual recertification is crucial in identifying the 140% rule situation, student status, and household composition changes. The 140% Rule is discussed in Section III.I. Failure to recertify tenants on an annual basis is cause for ADFA to issue IRS Form 8823 Report of Non-Compliance or Building Disposition. The timing of the recertification is critical to maintain compliance with the tax credit program. Recertifications must be completed within 12 months from the initial tax credit certification date or 12 months from the last tax credit recertification. A project may have Rural Development funding and tax credits. If Rural Development requires an interim recertification, a tax credit certification can be completed at the same time. The same income verifications may be used if they are not more than 120 days old. The required LIHTC Tenant Income Certification form must be completed for each tax credit recertification. ADFA will track the recertifications to ensure that no more than 12 months elapsed since the last tax credit recertification was completed

For HUD Section 8 tenants only, Treasury Regulations permit the submission of a letter from the contract administrator (e.g., local PHA) as verification that the family's income does not exceed the applicable Section 42 income limitation. ADFA will accept the form "Verification of Annual Income and Household Size", included herein as Exhibit T. This form is a verification of income; it is NOT a substitute for the Tenant Income Certification (TIC), which must be executed for every LIHTC household. Upon receipt of the Exhibit T, owner or manager must ensure the form is completed in its entirety and dated within the appropriate timeframe. The combined annual family income must be compared to the LIHTC income limit to ensure it falls at or below the limit. Any discrepancies between the application and income certified by the PHA will necessitate the use of third party verifications for all income. Owners or managers must remember that full-time student household eligibility must be verified.

The Fair Housing Law states that there are three types of Elderly housing:

The most serious action the IRS can take against an ownership is the recapture of credits previously claimed. Only the IRS determines this course of action. ADFA does not determine the consequences of reported non-compliance. If the owner discovers at any time

that credits have been claimed in error, miscalculated, or the basis was incorrectly listed, owner must complete IRS Form 8611 included herein as Exhibit G.

Rental projects that combine HOME funds with Low Income Housing Tax Credits (LIHTC) must be structured to ensure compliance with the requirements of both programs.

Tax credit projects must meet one of two minimum set-asides: 20/50 or 40/60. 20/50 means that at least 20 percent of the units must be rented to tenants with incomes at or below 50 percent of the area median income. The 40/60 set-aside means that at least 40 percent of the units must be rented to tenants earning at or below 60 percent of area median income. When combining HOME and tax credits, occupancy requirements depend on the type of credit taken and the type of HOME funding provided.

In order to take the 9 percent credit in conjunction with below-market HOME loans, joint HOME/tax credit projects must meet a higher occupancy standard than either the tax credit program or the HOME program. Together, they require 40 percent of the units to be occupied by tenants with incomes at or below 50 percent of area median income. Such projects are not eligible for the 130 percent increase in basis for projects in "qualified census tracts" or "difficult development areas". To receive the 130 percent increase, the project must either take the 4 percent credit of use the HOME funds at or above the applicable Federal rate.

In all other cases (when HOME funds are provided in some for other than a below-market interest rate loan) projects must ensure that they meet both sets of program rules. For example, a project receiving a market-rate loan can comply with both sets of rules by establishing a 20 percent set-aside for households with incomes at or below 50 percent of the area median income (as long as all remaining HOME-assisted units are leased to tenants with incomes at or below 80 percent of the area median income).

ADFA, as issuer of certain tax-exempt bonds, will monitor those projects that combined tax credits and tax-exempt bonds. ADFA will monitor those projects in accordance with the terms and conditions of specific Regulatory Agreements and applicable LIHTC program requirements.

The bond issuer, rather than the project owner, may make the election to satisfy the 20-50 test or the 40-60 test at the time the bonds are issued. This election may be entirely separate from the choice of minimum set aside for LIHTC purposes. Thus, it is not impossible that an issuer will elect the 20-50 test for a bond issue, while the project owner elects the 40-60 test for the LIHTC project financed by those bonds. Of course, the project would have to satisfy both the 20-50 test for bond purposes and the 40-60 test for LIHTC purposes. The rent restriction must comply with the terms of the Regulatory Agreement but must not exceed the LIHTC limit.

The property that is financed with both tax-exempt bonds and low income housing tax credits must comply with both programs. While some rules overlap, such as the 20/50 or 40/60 minimum set aside, the programs do not exactly match. The owner is responsible for knowing and complying with both sets of requirements.

RULES FOR COMBINING LIHTC AND TAX-EXEMPT BONDS

RULES FOR COMBINING LIHTC AND TAX-EXEMPT BONDS-Continued

Owners of qualified tax-exempt bond properties must comply with all regulatory agreements and program regulations. Owners' files must include the following:

* Initial and annual income certifications, income verifications/documents, etc.

* Complete records of unit history/occupancy reports

* Leases (6-month minimum term, as property cannot be used on a transient basis)

* Interim recertifications are required if number of occupants in the unit changes for any reason other than the birth of a baby to an occupant of the unit

* Copy of Certificate of Continuing Program Compliance

* Copy of IRS form 8703

X I. HOUSING AND DEVELOPMENT SOFTWARE

ADFA will implement the mandatory use of its web-based compliance and monitoring software. A separate procedures manual is available. Training sessions will be announced.

Adopted by the Board of Directors of the Arkansas Development Finance Authority this _______ day of _______________, 2007.

By: ____________________________

Charley Baxter, Chairman

ATTEST:

By: ________________________________

Mac Dodson, President/Secretary

GLOSSARY

20/50 TEST: Requirement whereby 20 percent or more of the residential rental units are rent-restricted and occupied by households with incomes of 50 percent or less of the area median gross income, adjusted for family size. This test is referred to as one of the "minimum set-aside" requirements. Compliance with the minimum set-aside requirements must be maintained at all times during the compliance period. Failure to meet the elected test will disqualify a development from being eligible for the credit.

40/60 TEST: Requirement whereby 40 percent or more of the residential rental units are rent-restricted and occupied by households with incomes of 60 percent or less of the area median gross income, adjusted for family size. This test is referred to as one of the "minimum set-aside" requirements. Compliance with the minimum set-aside requirements must be maintained at all times during the compliance period. Failure to meet the elected test will disqualify a development from being eligible for the credit.

30 PERCENT CREDIT: The 30-percent present value credit applies to acquisitions of existing housing or for new construction/rehabilitations which are federally subsidized. The 30 percent credit will yield, over the 10-year credit period, a tax benefit equal to 30 percent of qualifying costs. On an annual basis, this present value computation approximates a 4-percent figure each year over the credit period to arrive at the 30-percent credit.

70 PERCENT CREDIT: The 70-percent present value credit applies to new construction and qualifying rehabilitations. The 70-percent credit will yield, over the 10-year credit period, a tax benefit equal to 70 percent of qualifying costs. On an annual basis, this present value computation approximates a 9-percent figure each year over the credit period to arrive at the 70-percent credit.

ACCELERATED PORTION OF THE CREDIT: In exchange for 10 years of tax credits, under the low-income housing credit program, a building owner agrees to comply with IRC Section 42 for at least a 15-year period. This accelerates the tax benefits over a shorter term and lengthens compliance to 15 years. In each of the 10 years of the credit period, the building owner effectively receives an additional 1/3 of the credit which is accelerated from the 11th through 15th years. Thus, the credit for each year consists of both the "earned" portion (2/3) and the accelerated portion (1/3). It is the accelerated or unearned portion that must be recaptured as a result of decreases in qualified basis or disposition events.

APPLICABLE FRACTION: The applicable fraction, which is calculated for each building, is the lesser of (a) the number of LIHTC units divided by the total number of units in the building, or (b) the total rentable square footage of LIHTC units in the building divided by the total rentable square footage in the building.

The Applicable Fraction is established during rent-up. Once established, the Applicable Fraction for a building must never fall below this initial fraction. Failure to maintain applicable fraction could result in recapture of tax credits.

AREA MEDIAN GROSS INCOME (AMGI): A term which represents the midpoint (that is, half are above and the other half are below) income level for a given area. Those figures are published annually by HUD based on various population and earnings data. The AMGI figure, adjusted for family size, is used in the determination of whether or not a household qualifies as "low-income" for purposes of the LIHTC program.

BEDROOM ELECTION: This election allows owners of low-income buildings with allocations before 1990 or on financed buildings placed in service before 1990 to determine the gross rent limitation for rent-restricted units under the number of bedrooms method. In this method, a set occupancy is assigned based on the number of bedrooms contained in the low-income unit. Previously, the actual number of occupants was used to determine the rent restriction.

BELOW MARKET LOANS: A loan funded in whole or in part with federal funds, if the loan is less than the applicable federal rate in effect under IRC section 1271(d)(4). There are six basic categories of below market federal loan programs: