Tax Credits: Opportunities to Improve Oversight of the Low-Income Housing
Program (Testimony, 04/23/97, GAO/T-GGD/RCED-97-149).

GAO discussed its report on opportunities to improve oversight of the
Low-Income Housing Program.

GAO noted that: (1) a substantial majority of households served by the
program had incomes considered "very low" by the Department of Housing
and Urban Development and about three-fourths of all households
benefited either directly or indirectly from other types of housing
assistance; (2) GAO estimates the average tax credit cost per-unit, in
present value terms, to be about $27,300; (3) all the states had
developed qualified allocation plans required by the Internal Revenue
Code to direct tax credit awards to priority housing needs; (4) although
the states met tax code requirements, GAO identified several factors
that could affect the housing actually delivered over time; (5) some
states reserve discretion for amending or bypassing the allocation
process; (6) in addition, many tax credits that were initially allocated
may not have been used; (7) further, the long term economic viability of
tax credit projects as low-income housing has not been tested; (8) all
states had cost control procedures in place that were intended to help
ensure the reasonableness of project costs and tax credit awards; (9)
however, some projects lacked complete cost and financial data and some
key data used in determining the basis for tax credit awards were not
independently verified; (10) while states had established compliance
monitoring programs consistent with IRS regulations, the regulations did
not provide adequate assurance that states perform agreed upon
monitoring reviews; and (11) also, the Internal Revenue Service needs
additional information to adequately monitor states' tax credit
allocations and taxpayer compliance with credit requirements.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-GGD/RCED-97-149
     TITLE:  Tax Credits: Opportunities to Improve Oversight of the 
             Low-Income Housing Program
      DATE:  04/23/97
   SUBJECT:  Low income housing
             Rental housing
             Tax credit
             Disadvantaged persons
             Federal/state relations
             Housing programs
             Monitoring
             State-administered programs
             Cost control
             Tax law
IDENTIFIER:  HUD Low Income Housing Tax Credit Program
             
******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO report.  Delineations within the text indicating chapter **
** titles, headings, and bullets are preserved.  Major          **
** divisions and subdivisions of the text, such as Chapters,    **
** Sections, and Appendixes, are identified by double and       **
** single lines.  The numbers on the right end of these lines   **
** indicate the position of each of the subsections in the      **
** document outline.  These numbers do NOT correspond with the  **
** page numbers of the printed product.                         **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
** A printed copy of this report may be obtained from the GAO   **
** Document Distribution Center.  For further details, please   **
** send an e-mail message to:                                   **
**                                                              **
**                                            **
**                                                              **
** with the message 'info' in the body.                         **
******************************************************************


Cover
================================================================ COVER


Before the Subcommittee on Oversight, Committee on Ways and Means,
House of Representatives

For Release on
Delivery Expected at
1:30 p.m., Wednesday
April 23, 1997

TAX CREDITS - OPPORTUNITIES TO
IMPROVE OVERSIGHT OF THE
LOW-INCOME HOUSING PROGRAM

Statement of James R.  White, Associate Director, Tax Policy &
Adminstration Issues, General Government Division

GAO/T-GGD/RCED-97-149

GAO/GGD-97-149T


(268796)


Abbreviations
=============================================================== ABBREV

  IRS - x
  HUD - x

TAX CREDITS:  OPPORTUNITIES TO
IMPROVE OVERSIGHT OF THE
LOW-INCOME HOUSING PROGRAM
==================================================== Chapter STATEMENT

Madam Chairman and Members of the Subcommittee,

We appreciate being here this afternoon to discuss our recently
issued report entitled Tax Credits:  Opportunities to Improve
Oversight of the Low-Income Housing Program (GAO/GGD/RCED-97-55,
March 28, 1997).  Currently, the tax credit is the largest federal
program for funding the development and rehabilitation of rental
housing for low-income households.  Under this program, the states
award tax credits that could cost federal taxpayers as much as $3
billion per year. 

Our report, which is addressed to you, Madam Chairman, and the
Chairman of the Ways and Means Committee, answers questions about the
characteristics of tax credit projects and their residents and the
controls the Internal Revenue Service (IRS) and the states have over
the program.  More specifically, with respect to controls we were
asked to assess IRS and state controls for ensuring that (1) state
priority housing needs are met; (2) housing project costs, including
tax credit costs, are reasonable; and (3) states and project owners
comply with program requirements. 

In answering these questions, our report makes the following four
main points: 

  -- A substantial majority of the households served by the program
     had incomes considered "very low" by the Department of Housing
     and Urban Development and about three-fourths of all households
     benefited either directly or indirectly from other types of
     housing assistance.  We estimate the average tax credit cost
     per-unit, in present value terms, to be about $27,300. 

  -- All the states had developed qualified allocation plans required
     by the Internal Revenue Code to direct tax credit awards to
     priority housing needs.  Although the states met tax code
     requirements, we identified several factors that could affect
     the housing actually delivered over time.  Some states reserve
     discretion for amending or bypassing the allocation process.  In
     addition, many tax credits that were initially allocated may not
     have been used.  Further, the long term economic viability of
     tax credit projects as low-income housing has not been tested. 

  -- All states had cost control procedures in place that were
     intended to help ensure the reasonableness of project costs and
     tax credit awards.  However, some projects lacked complete cost
     and financial data and some key data used in determining the
     basis for tax credit awards were not independently verified. 

  -- While states had established compliance monitoring programs
     consistent with IRS regulations, the regulations did not provide
     adequate assurance that states perform agreed upon monitoring
     reviews.  Also, IRS needs additional information to adequately
     monitor states' tax credit allocations and taxpayer compliance
     with credit requirements. 

Before elaborating on these points I would like to describe our
methodology and provide some background about how the low income
housing tax credit program works and the responsibilities of the IRS
and states for administration and oversight of the program. 

Our analysis of the low-income housing tax credit program is based
primarily on a survey of tax credit policies and procedures in 54
state tax credit allocating agencies, a review of state files for 423
randomly selected housing projects, and a survey of project managers
for these projects.  We also reviewed IRS' low-income housing tax
credit procedures and programs. 


   HOW THE PROGRAM WORKS
-------------------------------------------------- Chapter STATEMENT:1

The low income housing tax credit program is a joint federal, state
and private sector initiative.  Figure 1 attached to this statement
illustrates for a simple case how tax credits help finance low-income
housing development.  Under the program, a developer finances a low
income housing project in part using a private mortgage, with
payments made out of rental revenues, and in part using equity paid
into the project from investors who receive the credit.  The greater
the private financing, the smaller the amount of tax credit needed. 

The process of awarding tax credits to private investors begins with
IRS annually allocating tax credits to each state housing agency in
an amount equal to $1.25 per state resident.  Developers proposing to
build low-income housing apply to the state agencies for credits. 
Winning developers receive credits which they in turn offer, in
effect sell, to private investors, often organized into partnerships
by syndicators, who use the credits to offset taxes otherwise owed on
their tax returns.  In return for the credits, the private investors
provide equity financing for the projects.  This equity financing
fills the gap between the development costs and the non-tax credit
financing.  The equity paid into a project is less than the sum of
the tax credits.  The difference provides the investors with a rate
of return over 10 years as well as compensation for housing project
evaluation and monitoring.  A complication not shown in the figure is
that many projects also receive other housing subsidies. 

About $300 million in new credits are made available nationally each
year for award to new housing projects.  Assuming project owners
remain eligible, they would be entitled to take the $300 million in
credits each year for 10 years.  Thus, if this occurred, in any one
year, 10 years worth of federal tax credits would be outstanding and
the aggregate annual cost to the federal government would be $3
billion. 

The states and IRS share responsibility for administering the tax
credit program.  Once projects have been placed in service, state
agencies are responsible for monitoring the projects for compliance
with federal requirements concerning household income and rents and
project habitability.  Noncompliance with these requirements may
result in IRS recapturing or denying previously issued or used tax
credits. 

IRS is responsible for issuing regulations on state monitoring
requirements, ensuring that taxpayers take no more tax credits than
they are entitled to take, and ensuring that states allocate no more
credits than they were authorized to allocate.  In implementing these
responsibilities, IRS requires annual reports from the states on the
amount of tax credit allocations made in total and amounts awarded to
individual projects.  IRS also requires taxpayers to disclose tax
credit information on their tax returns and requires the states to
report findings of project noncompliance. 


   HOUSING DELIVERED UNDER THE
   PROGRAM
-------------------------------------------------- Chapter STATEMENT:2

We estimated, based on our random sample, that about 4,100 properties
with about 172,000 tax credit qualified units were placed in service
in the continental United States between 1992 and 1994.  We also
estimated that, for these projects, the states annually awarded tax
credits with a potential value over their 10-year lifetime of about
$2 billion (about $1.6 billion in present value terms), or about $6.1
billion for the three years combined. 

On the basis of information from our survey of property managers, we
estimated that the 1996 average annual income of households in units
qualifying for tax credits was about $13,300.  The distribution of
incomes is shown in figure 2, which is attached to this statement. 
About three-fourths of tax credit households met HUD's definition of
"very low income"--that is, their incomes were below 50 percent of
their area's median income.  About 71 percent of the tax credit
households, benefited directly or indirectly from one or more types
of housing assistance besides tax credits.  One type of housing
assistance, direct rental assistance, enabled the tax credit program
to serve many households whose reported income was well below the
qualifying limits established by the program.  Overall, an estimated
39 percent of the households received direct rental assistance.  The
average income for these households was about $7,900. 

Tax credit households were small--about two-thirds were one or two
person households.  About a quarter of the projects were developed
primarily to serve the elderly. 

Tax credit properties were located throughout the country.  The most
common type of property was a walk-up/garden-style apartment building
but properties ranged from row houses to elevator buildings.  Most of
the projects were newly constructed. 

The average monthly rent was about $450.  For some tenants rental
payments were covered in part by other federal housing assistance. 

We estimated that for the tax credit properties placed in service
between 1992 and 1994, the states had annually awarded tax credits
with a potential value over 10 years of about $2 billion (about $1.6
billion in present value terms).  Thus, the taxpayer costs for the
tax credits attributable to these three years could be as high as
$6.1 billion over the 10-year credit period.  We also estimated that
the present value of the average tax credit cost per unit would be
about $27,310.  As shown in figure 3, which is attached to this
statement, about 60 percent of the units had tax credit costs at or
below the estimated average and about 2 percent had tax credit costs
of $100,000 or more.  The federal costs of the tax credits is a
function of many factors, including property development costs and
the market price of the tax credit. 

Project development costs, including land and building acquisition
outlays, construction costs, builders' profit, and financing costs,
varied widely.  We estimate that the average cost of developing the
units was about $60,000.  About two-thirds of these units cost less
than or the same as the average unit.  As shown in figure 4, which is
attached to this statement, the per-unit costs of the properties
varied widely.  About 10 percent of the properties cost less than
$20,000, and about 10 percent cost more than $100,000--including 3
percent whose costs exceeded $160,000 per unit.  Development costs
may vary because of differences in the physical characteristics of
properties, broader community development needs, and the extent to
which tax credit allocating agencies use various controls to limit
costs. 


   STATE CONTROLS FOR ALLOCATING
   CREDITS TO HOUSING NEEDS VARY
-------------------------------------------------- Chapter STATEMENT:3

All the states had developed qualified tax credit allocation plans
required by the Internal Revenue Code to direct tax credit awards to
meet priority housing needs.  The plans generally targeted the credit
to the priority housing needs identified by the states.  Consistent
with the latitude given them in the Code, the states had defined and
weighted the selection criteria for awarding credits in different
ways.  Most states used some sort of scoring system to rank project
proposals.  The states also used varying amounts of data and analyses
in assessing housing needs. 

Although all states had adopted required allocation plans for meeting
state set housing priorities, we identified several factors that
could affect the housing actually delivered over time. 

  -- One factor involves the use of discretionary judgment.  Nearly
     all of the agencies reserved some discretion for amending or
     bypassing their allocation process.  We recognize that
     discretion can be beneficial --it can target needs resulting
     from unforeseen circumstances.  But, unless the use of
     discretion is well documented and made public it could undermine
     the credibility of the allocation process.  For example, in one
     recently completed allocation cycle in Texas senior managers
     overrode over half the decisions made through the allocation
     process without documenting their decisions. 

  -- A second factor involves the timely use of tax credits.  Data
     from the states, IRS, and a study contracted by HUD suggest that
     the states may not be fully using their tax credit allocations. 
     The data show a significant gap between the amount of tax
     credits that have been allocated by the states to proposed
     projects and the tax credits that have been awarded to projects
     when they were completed and been placed in service.  For
     example, IRS data showed that the cohort of projects proposed in
     1992 received tax credit allocations of about $322 million. 
     However, by the end of calendar year 1994 only about half the
     credits had been actually used--that is, awarded to projects
     placed in service.  These data raise the question of whether the
     allocating agencies produced the total amount of housing that
     the federal government was prepared to fund.  From the available
     data, we cannot determine how much of the total federal
     allocation that has not been awarded may have lapsed and how
     much may have been reallocated for future use. 

  -- A third factor involves the long-term economic viability of the
     tax credit projects after the 15 year tax credit compliance
     period ends.  Under the Code, projects receiving tax credits are
     required to have an extended-use agreement requiring that the
     property serve low-income tenants for 30 years, but with a
     contingency clause that allows for conversion to market rate
     housing after 15 years under certain conditions.  Within the
     next decade, the first properties subsidized with tax credits
     will enter the period covered by extended-use agreements. 
     Whether these properties convert to market rate housing,
     continue to provide high-quality housing for low-income tenants,
     or gradually deteriorate will depend on such factors as the
     economics of the alternative uses, the states' ability to find
     buyers willing to keep the properties in low-income use, and the
     need to obtain additional subsidies. 


   STATE CONTROLS FOR ENSURING THE
   REASONABLENESS OF PROJECT COSTS
   CAN BE STRENGTHENED
-------------------------------------------------- Chapter STATEMENT:4

All states had some cost control procedures in place that were
intended to help ensure the reasonableness of tax credit awards. 
However, we identified opportunities for the states to improve their
cost controls.  Figure 5, which is attached to this statement,
provides an overview of the development costs or uses of funds and
the financing or sources of funds for projects placed in service from
1992 through 1994.  The height of the bars represents total
development costs or the uses of funds.  The financing of these
development costs, the sources of funds, was provided by the three
components shown: 

  -- Equity paid into projects by tax credit investors, which was
     about $3.1 billion and which was generated by about $6.1 billion
     in tax credits investors can claim on their tax returns over 10
     years. 

  -- Commercial mortgage loans of about $3.8 billion. 

  -- Concessionary financing of about $3.8 billion, which was
     provided primarily by other federal housing programs. 

Controlling the amount of tax credits awarded to individual projects
limits federal taxpayers' cost for the project and allows a state,
with an overall tax credit allocation proportional to its population,
to finance more projects.  To do this the states should consider

  -- the reasonableness of a project's development cost;

  -- the extent of a project's financing gap, which is the difference
     between the cost of a project and the amount of non-tax credit
     financing that a project can raise to cover those development
     costs; and

  -- the yield obtained from a project's tax credit award, which is
     the amount of equity investment a project could raise for each
     tax credit dollar received. 

All state agencies had controls over development costs.  Many states
relied on HUD cost standards, others believed their own standards
were more effective in limiting costs, and some relied on their
staffs' expertise because they said that differences in project types
and location made setting standards impractical.  These standards
acted as a ceiling on costs.  Additionally, most supplemented these
practices by using competition among project developers to control
costs, i.e., cost was a factor in ranking projects applying for tax
credit awards.  State agency practices for determining the
reasonableness of the non-tax credit financing varied, but they
generally included reviewing projects' rents and operating expenses,
private mortgage terms, and non-tax credit public subsidies--in the
case of HUD financing the evaluation is called a "subsidy layering
review". 

As already mentioned, the equity yield per dollar of tax credit is a
factor influencing the federal cost of an individual project and the
$3.1 billion in equity paid in by investors during 1992 through 1994
was generated by $6.1 billion in tax credits.  This works out to
about $0.53 on the dollar.  States generally relied on the market to
determine the yield obtained from a project's tax credit award.  The
tax credit yield or price has gone up over time, from about $0.45 in
1987 to over $0.60 in 1996, according to several major syndicators
and state allocating agency officials. 

In controlling costs--that is, in evaluating the reasonableness of
project costs, the financing gap, and the tax credit
price--allocating agencies are largely dependent on information
submitted by developers.  To the extent that the agencies do not have
complete and reliable information, they lack assurance about the
effectiveness of their cost controls. 

We found some control weaknesses in terms of the way states assured
the reliability of information from developers about their sources
and uses of project funds.  For example, although all but one state
required some form of independent verification of cost and financing
data, the scope of the required cost verification work varied.  It
ranged from audits to more limited work, that did not require
verification of costs included in the base for calculating the tax
credit award.  Overall, we estimated that for about 14 percent of the
total projects, the states lacked complete information on the sources
and uses of project funds.  Without assurance of the validity of
developer costs and without a complete and documented basis for
determining equity needs, such as a detailed sources and uses of
funds analysis, states are vulnerable to providing more (or fewer)
credits to projects than needed. 

Accordingly, we recommended that the Commissioner of Internal Revenue
amend regulations for the tax credit program to establish clear
requirements for ensuring independent verification of key information
on sources and uses of funds submitted to states by developers. 


   STATE AND IRS OVERSIGHT CAN BE
   IMPROVED
-------------------------------------------------- Chapter STATEMENT:5

The Internal Revenue Code provides for dual oversight of the tax
credit program by state tax credit allocating agencies and IRS.  In
general, we found that not all allocating agencies fulfilled the
requirements of their compliance monitoring programs; and although
IRS has been developing programs, it did not have sufficient
information to determine state or taxpayer compliance. 


      STATE MONITORING PROGRAMS
------------------------------------------------ Chapter STATEMENT:5.1

In general states are responsible for monitoring project compliance
with rent, income, and habitability requirements after the projects
are placed in service and for reporting any noncompliance to IRS.  In
1995, several states did not do the number of desk reviews and
on-site inspections they had agreed to do.  Because IRS' regulations
do not require states to submit annual reports to IRS on the number
of monitoring inspections made, IRS was not in a position to readily
determine whether states met their agreed-upon monitoring
responsibilities.  Also, IRS' monitoring regulations do not require
states to make on-site visits to projects or obtain information from
other sources, such as local government reports on building code
violations, that would allow states to detect violations of the
Code's habitability requirements.  For IRS to better ensure that
habitability problems are identified during monitoring reviews,
states would have to do on-site inspections or obtain information on
these types of problems from other sources.  We also found that IRS
was not collecting enough information from states on the number of
units in each project where states found noncompliance for IRS to
determine whether the noncompliance has a tax consequence for the
project owners. 

Accordingly, we recommended that the Commissioner of Internal Revenue
amend regulations for the tax credit program to (1) require that
states report sufficient information about monitoring inspections or
reviews, including the number and types of inspections made, so that
IRS can determine whether states have complied with their monitoring
plans; and (2) require that states' monitoring plans include specific
steps that will provide information to permit IRS to more effectively
ensure that the Code's habitability requirements are met.  We also
recommended that IRS explore modifying the form states use to report
noncompliance so that IRS can better determine whether the
noncompliance has a tax consequence for the project owners. 


      IRS COMPLIANCE OVERSIGHT
      ACTIVITIES
------------------------------------------------ Chapter STATEMENT:5.2

IRS is responsible for ensuring that taxpayers claim only those tax
credits for which they are entitled and for ensuring that states do
not exceed their annual tax credit ceilings. 

In 1995, IRS instituted an audit program to determine whether
taxpayers are entitled to the credits claimed on their tax returns. 
As of the end of fiscal year 1996, IRS had completed work on 35 audit
cases and found 12 to be in noncompliance. 

IRS is relying on the results of its audit initiative to provide
estimates on the extent and types of noncompliance that exist in the
tax credit program.  It is important for IRS to have information on
compliance so that it can determine how best to allocate its
compliance resources.  However, IRS' current audit program is not
based on a random sample of returns and will not provide
statistically reliable compliance data. 

With respect to monitoring state use of tax credits, IRS is currently
developing a document matching program using state tax credit reports
to determine whether states have allocated more credits than allowed
by law.  However, the reports do not contain information on the
allocation year of the tax credits that developers returned to the
allocating agencies for reallocation to other projects.  IRS needs
this information in order to determine whether states stay within
their tax credit ceilings.  Collecting this additional data on
returned credits would also allow IRS to determine whether the states
are fully using their tax credit allocations.  As I indicated
earlier, a significant gap exists between the amount of tax credits
that have been allocated by states and the amount of credits that
states and IRS records show were awarded to projects that were placed
in service. 

To supplement its tax credit audit initiative, IRS is exploring the
possibility of computer-matching these data against tax credit
amounts reported on housing project partnership returns.  However,
this match would not detect noncompliance at the partner level.  But
overreporting of tax credits by partners could be detected by
matching tax credits reported on the Schedule K-1s, which shows the
individual partners' credit allocations, to the partners' income tax
returns.  In a June 1995 report on partnership compliance, we
recommended that IRS match Schedule K-1 to tax returns.\1 However,
resource constraints have prevented IRS from transcribing all the
Schedule K-1s reporting tax credits it receives so that it could have
an effective matching program. 

Accordingly, we recommended that the Commissioner of Internal Revenue
(1) explore alternative ways to develop an estimate of tax credit
compliance so that IRS can better determine the resources needed to
address noncompliance and (2) explore alternative ways to obtain
better information to verify that states' allocations do not exceed
tax credit authorizations. 


--------------------
\1 Tax Administration:  IRS' Partnership Compliance Activities Could
be Improved (GAO/GGD 95-151, June 16, 1995). 


   INDEPENDENT OVERSIGHT OF THE
   TAX CREDIT PROGRAM
-------------------------------------------------- Chapter STATEMENT:6

Unlike most programs operated by state and local governments that
receive federal financial assistance, the low-income housing tax
credit program is not covered by the Single Audit Act.  The Single
Audit Act, which is an important accountability tool for the hundreds
of billions of dollars of federal financial assistance administered
by state and local governments and nonprofit organizations, does not
apply to tax credits because credits are not considered federal
financial assistance under the Office of Management and Budget's
implementing guidance.  Subjecting the low-income housing tax credit
program to the single audit process may be a more efficient,
effective, and less federally intrusive way of monitoring state
agency controls than other types of independent audits. 

Accordingly, to help ensure appropriate oversight of state allocating
agencies' overall compliance with tax credit laws and regulations, we
recommended that the Director, Office of Management and Budget,
incorporate the low-income housing tax credit program in the
definition of federal financial assistance included in implementing
guidance for the Single Audit Act so that the program would be
subject to audits conducted under the Single Audit Act. 

Madam Chairman, this concludes my prepared statement.  I would be
pleased to answer any questions. 


FIGURES USED IN GAO'S LOW-INCOME
HOUSING TAX CREDIT TESTIMONY
=========================================================== Appendix 0


   FIGURES
--------------------------------------------------------- Appendix 0:1

Figure 1:  Transferring Tax Credits From the Federal Government to
the Private Sector

Figure 2:  Estimated 1996 Incomes of Households in Tax Credits Units

Figure 3:  Estimated Average Per-Unit Credit Costs of Properties
Placed in Service, 1992-94

Figure 4:  Estimated Average Per-Unit Develpment Costs of Tax Credit
Properties Placed in Service, 1992-94

Figure 5:  Estimates on Housing Project Sources and Uses of Funds



   (See figure in printed
   edition.)



   (See figure in printed
   edition.)



   (See figure in printed
   edition.)



   (See figure in printed
   edition.)



   (See figure in printed
   edition.)


*** End of document. ***