Most operators believe that if you correct noncompliance inside the correction period, the Form 8823 goes away. It does not.

26 CFR 1.42-5(e)(3) requires the agency to file Form 8823 no later than 45 days after the end of the correction period, and no earlier than the end of that period, whether or not the noncompliance or failure to certify is corrected. The agency explains the nature of the noncompliance on the form and indicates whether the owner corrected it.

So once the agency has determined that reportable noncompliance occurred, the objective is not to avoid the 8823. It is to have it filed showing that the noncompliance was corrected.

That distinction changes what preparation is for, and it is worth understanding before the next review.

The Sequence, In Order

If you have just been told there is a problem, this is the shape of what follows.

The agency identifies noncompliance or a failure to certify, and gives the owner written notice.

A correction period runs. Its length is set by the agency within the limits the regulation permits, and extensions are possible in defined circumstances. Confirm the period and its end date in writing rather than assuming it.

The agency files Form 8823, no earlier than the end of the correction period and no later than 45 days after it. The form states the nature of the noncompliance and whether it was corrected.

If the correction happens within three years after the end of the correction period, the agency files a further Form 8823 reporting the correction and the date the taxpayer returned to compliance.

What the IRS does with any of it is a separate question, addressed at the end of this post.

Note where the leverage sits. Everything before the first filing is within the correction period. Everything after it is a record that already exists.

What The Agency Actually Reviews

The monitoring requirements are prescribed, and they are narrower than the anxiety around them suggests.

Under §1.42-5(c)(2)(ii) and (iii), the agency must inspect all buildings in the project and conduct the required low-income certification review using at least the applicable minimum unit sample. That review covers the low-income certifications, the supporting documentation for those certifications, and the rent records for the tenants in the sampled units.

The sample is not simply 20 percent. The current minimum sample-size rule uses the applicable minimum unit sample-size table. The 2016 revenue procedure originally permitted the lesser of 20 percent of the low-income units or the table figure, but Treasury and the IRS subsequently removed that 20-percent option in the final regulations. For large projects, that table can produce a minimum that is well below one-fifth of the low-income units.

Three things follow.

• The sample is a minimum, not a maximum. The table establishes the minimum number of units the agency must select for the required inspection and certification review. An agency can review more units if appropriate.

• Every building in the project must be physically inspected, even though only a sample of units is subject to the required inspection and certification review. Those are two different exercises with two different scopes.

• And the review is of three things per sampled unit, not one: the certification, what supports it, and the rent record. A certification that is arithmetically correct but unsupported can still result in a finding. So can a correct certification sitting behind a rent that was charged above the limit.

The 21-Year File

Here is the retention requirement most operators have wrong, and it has a name in the industry for a reason.

Under §1.42-5(b), owners must retain the records required for each qualified low-income building for each year of the compliance period. Those records are broader than tenant certifications alone: the number of units and the applicable fraction, the rents and utility allowances, vacancies, income certifications and supporting documentation, and basis information, among others.

The general retention period is at least six years after the due date, with extensions, for filing the federal income tax return for that year.

But the records for the first year of the credit period have a longer rule. They must be retained for at least six years beyond the due date, with extensions, for filing the return for the last year of the building's compliance period.

For a standard 15-year compliance period, that produces the 21-year retention period practitioners often call the 21-year file. These are the records most likely to have been lost to an office move, a management company transition or a server migration.

Two practical consequences.

If you acquired a property mid-compliance-period, the first-year files are not yours to have created and they are still your obligation. The regulation itself notes that when a building is transferred, the transferee should obtain the first-year information from the transferor in order to substantiate credits claimed. Establish whether you actually received it at transition, not when someone asks for it.

And a records policy applying a single shorter retention period across the portfolio can destroy first-year files years before their extended retention period expires.

The Categories You Are Being Measured Against

The IRS Guide for Completing Form 8823 sets out the categories of noncompliance an agency reports. Knowing the list is more useful than a generic file checklist, because the categories describe how a finding will be characterised.

Five are worth knowing by name, because each is checkable in advance.

• Violations of the available unit rule under section 42(g)(2)(D)(ii). One leasing decision can put multiple over-income units into this category at once.

• Violations of the vacant unit rule under §1.42-5(c)(1)(ix).

• Low-income units occupied by nonqualified full-time students.

• Owner did not properly calculate utility allowance, which is its own category, distinct from rent overcharge.

• Owner has failed to respond to agency requests for monitoring reviews. That one is worth pausing on. It is a category of noncompliance in its own right, and it is entirely within the operator's control.

The Guide contains further categories, including transient use, failure to execute and record the extended use agreement within the prescribed time, and a general "other noncompliance" category. The full list is worth reading once, because these are named findings with specific regulatory hooks rather than vague quality concerns.

Correction, And What Responsiveness Buys

The Guide is direct about the strategy and equally direct about its limits. From the owner's perspective, the best approach is to address noncompliance identified by the state agency quickly, so that the initial Form 8823 indicates the noncompliance was corrected.

From the IRS point of view, the Guide says the owner's responsiveness is indicative of due diligence, but does not preclude initiating an audit.

Read both halves. Fast correction improves the record on the form and demonstrates diligence. It does not guarantee anything downstream.

So the file has a history, not a verdict. What it shows is whether problems were found, whether they were fixed, and how quickly.

What Actually Fails A File Review

Four patterns, and none of them is exotic.

The certification is fine and the support is missing. Third-party verification that was obtained, used, and never filed. The calculation is right and unprovable.

The rent record does not match the certification. Two systems, two numbers, nobody reconciling them. The reviewer looks at both.

The reasoning is undocumented. Which standard was applied to this household and why, which unit was comparable to which, which utility allowance method was used in which year. All defensible at the time and none of it written down.

And the file cannot be produced quickly.  A file that exists but cannot be found within the response window is, for practical purposes, not much better than one that does not exist. Centralised document storage across a portfolio is what turns retrieval into a query rather than a search. Failure to respond to agency requests is separately a named category of noncompliance. 

Six Things To Do Before The Next Review

• Identify your first-year files and protect them separately:
  Different retention rule, longer period, and the ones most likely to have gone missing.

• Self-sample:
  Pull a sample on the same basis the agency would, review the same three things per unit — certification, supporting documentation, rent record and see what you find.

• Check the named categories rather than a generic checklist:
  Student status, utility allowance method, available unit rule decisions, vacant unit rule, transient use. Each has a specific hook and each is checkable in advance.

• Reconcile the rent record to the certification:
  Any difference is a finding waiting to be made by someone else.

• Make the file retrievable, not merely complete:
  If producing a file takes a week, that is the problem to fix first.

• And write down the reasoning as you go
  This is the cheapest thing on the list and the one that cannot be done retrospectively. It matters more in areas where the position is genuinely unsettled, such as which income standard applied to which unit and when.

The Point Of All This

An 8823 is a report, not itself a penalty. It records what the agency found and whether the noncompliance was corrected.

What follows from it is a separate question, and the Guide is explicit that responsiveness does not preclude an IRS audit.

Which means the file review is not the risk. The file is. By the time an agency arrives, everything that will be found has already happened. The only variables left are whether you can produce the records, whether they support what the certifications say, and how fast you respond.

All three are decided months earlier, by whoever was keeping the file.

FAQ

1. Does correcting noncompliance prevent a Form 8823?
No. Under §1.42-5(e)(3) the agency must file Form 8823 no later than 45 days after the end of the correction period and no earlier than the end of that period, whether or not the noncompliance is corrected. The form indicates whether the owner corrected it.

2. How long is the correction period?
It is set by the agency within the limits the regulation permits, and extensions are possible in defined circumstances. Confirm the period and its end date in writing with the agency.

3. How many units does the agency review?
The agency inspects all buildings in the project and reviews low-income certifications, supporting documentation and rent records for at least the applicable minimum unit sample. The current rule uses the minimum unit sample-size table. The earlier 20-percent option from Rev. Proc. 2016-15 was removed by the subsequent final regulations.

4. How long must LIHTC records be kept?
Generally at least six years after the due date, with extensions, for filing the federal income tax return for that year. Records for the first year of the credit period must be kept for at least six years beyond the due date for filing the return for the last year of the building's compliance period.

5. What are the 21-year files?
Practitioner shorthand for the first-year records, which carry the longer retention requirement described above. For a standard 15-year compliance period that works out at around 21 years.

Sources: 26 CFR 1.42-5, Monitoring compliance with low-income housing credit requirements, including the recordkeeping and retention provisions at (b), the certification and review provisions at (c), and the correction period and Form 8823 filing requirements at (e); Cornell Legal Information Institute text of 26 CFR 1.42-5; IRS Publication 5913, Guide for Completing Form 8823, for the categories of noncompliance and the guidance on owner responsiveness. The minimum unit sample-size rule is in the current regulations; the earlier 20-percent option in Rev. Proc. 2016-15 was removed by subsequent final regulations. State housing finance agency policy under the applicable Qualified Allocation Plan may impose additional monitoring and recordkeeping requirements. This article describes general concepts and is not accounting, tax or legal advice. Confirm your position with the agency that has jurisdiction over the building and with a qualified compliance professional.