A. J. Johnson Consulting Services, Inc.

During an audit, a primary point of examination by the IRS will be the reconciliation of eligible basis, and identification of large, unusual or questionable items. Reconciliation of Eligible Basis The eligible basis shown on Line 7 of the 8609 and Line 1 of the 8609-A should match. If they don’t, taxpayers must be prepared to explain why. Section 42(m)(2) requires that housing credit agencies not allocate more credit to a project than the amount necessary for the financial feasibility of the project. To ensure this, the state agency is required to evaluate the need for the credit at three separate points of the development process: (1) when the credits are initially applied for; (2) when the credit allocation is made; and (3) when the building is placed in service. This final evaluation (placed in service) must occur no later than the date the state agency issues the 8609s for the project. Prior to obtaining an 8609, owners are required to submit a cost certification. If the project has more than ten units, a CPA must do the cost certification; for projects of 11 units or less, the state agency may require that a CPA prepare the certification. The eligible basis shown on the cost certification should match the eligible basis on the 8609 and 8609-A. Requirements of the Cost Certification At a minimum, the final cost certification must include the following:

All costs, including those that will be in eligible basis and those that will not be in eligible basis. In addition to basic construction costs, the following must be included in the certification:
1. Site acquisition costs;
2. Construction contingency;
3. General contractor’s overhead and profit;
4. Architect’s and engineer’s fees;
5. Permits and survey fees;
6. Insurance premiums;
7. Real estate taxes during construction;
8. Title and recording fees;
9. Construction period interest;
10. Financing fees;
11. Organizational costs;
12. Rent-up and marketing costs;
13. Accounting and auditing costs;
14. Working capital and operating deficit reserves;
15. Syndication and legal fees; and
16. Developer fees

If an existing building is bought and rehabilitated, the acquisition costs for the building must be shown separately from the rehab costs and must be distinguished from the cost of the land. Large, Unusual or Questionable Items (LUQs) During an examination, the IRS will look for specific costs that are large, unusual or questionable. The agent will:

Consider the inherent character of the cost categories. They will ensure that categories not includable in eligible basis, such as the cost of land, were not shown in eligible basis on the cost certification;
Consider the beneficial effects of how an item was reported. For example, allocation of the purchase price of an existing building between the building and the land. Another example would be the case of a multiple building project. Unless the actual costs associated with each building were tracked and cost certified, the total eligible basis for the entire project should be allocated among the buildings based on square footage;
Consider costs that should have been in the final cost certification, but were not. Examples include partnership organizational costs, rent-up and marketing costs, and syndication fees. Even though not includable in eligible basis, these costs must be accounted for in order to ensure that such costs have not be "hidden" among allowable cost items; and
Consider line items on the cost certification that are an accumulation of a larger number of separate costs. In such cases, the taxpayer will be required to explain any underlying costs.

Even when all items that are clearly excludable have not been placed into basis, the IRS will focus on two additional issues:

The comparative size of the cost to total eligible basis; and
The absolute size of the cost, even if comparably small, if the dollar value does not appear commensurate with the character of the cost.

Because of the importance of the cost certification to the final establishment of eligible basis, it is important that developers of LIHTC projects retain the services of accountants skilled in the LIHTC program. Issues of eligible basis are unique to the tax credit program, and only accounting firms that specialize in the Section 42 program should be used for the preparation of cost certifications.

Eligible Basis: IRS Reconciliation of Allowable Costs

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