Avoiding the 8823: Common LIHTC Non-Compliance Pitfalls and How to Fix Them

In the LIHTC world, there is one form number that makes developers sweat: The 8823.

Formally known as the “Low-Income Housing Credit Agencies Report of Noncompliance,” it is essentially a “tattletale form.” It is the document HHFDC files with the IRS to report that you broke the rules.

Many owners think an 8823 means immediate financial doom. It doesn’t. But it does mean your property is now on the IRS “Watch List,” and if you have investors (Limited Partners), they are likely blowing up your phone demanding answers.

At Hawaii Affordable Properties, Inc. (HAPI), we specialize in fixing broken properties. Here is the insider reality of what triggers an 8823 in Hawaii, and how to scrub your files clean before the IRS strikes.

Key Takeaways

• The Permanent Record: An 8823 stays in the IRS database forever. Even if you “cure” it, the record remains visible to future investors.
• The #1 Trigger: Physical Failures (like rusted railings) account for 75% of all 8823s, far outnumbering file errors.
• The Financial Stakes: Know the difference between Disallowance (losing this year’s credits) and Recapture (paying back past credits with interest).
• The “Next Available Unit” Trap: This is the complex math that kills mixed-income projects.

The “Physical Trap”: NSPIRE & Salt Air

It’s not just about paperwork.

Most owners obsess over tenant files, but 75% of 8823s are triggered by physical inspections. HHFDC uses the new NSPIRE (National Standards for the Physical Inspection of Real Estate) protocol.

The Hawaii Risk: Our salt air is brutal. A rusted handrail or a spalling lanai isn’t just “deferred maintenance”—it is a Health & Safety violation.

• The Rule: If HHFDC finds a safety hazard (e.g., a blocked fire egress or a window that won’t stay open), they file an 8823 immediately.
• The Fix: You cannot “retroactively” fix a physical failure. The 8823 will be filed. The only goal is to get it marked “Corrected” by fixing the issue within 72 hours.

The “Big Three” File Pitfalls

Why Hawaii projects fail file audits.

1. The Utility Allowance (UA) Trap

In Hawaii, electricity costs are volatile. HPHA and the counties update their Utility Allowance schedules annually.

• The Mistake: You are using the 2025 UA schedule, but the 2026 schedule came out last month and lowered the allowance.
• The Consequence: Your “Net Tenant Rent” is now over the allowable limit (Gross Rent Violation). You must refund the difference to the tenant immediately to “cure” the 8823.

2. The “Student Rule” (University of Hawaii Effect)

LIHTC is for working families, not college dorms. Generally, a household comprised entirely of full-time students is ineligible.

• The Trap: A single mom goes back to school full-time at KCC. She might disqualify her unit unless she meets a specific exception (e.g., receiving TANF or in a job training program).
• The Fix: You need a robust “Student Status Verification” form signed at every recertification.

3. The “Next Available Unit” Rule (The 140% Math)

This is the most complex rule for mixed-income projects.

The Scenario:

• You rent a unit to a family earning $50,000 (qualified).
• Next year, they earn $75,000. This is 150% of the income limit.
• Are they out? No. They can stay.
• The Trap: The Next Available Unit of comparable size MUST be rented to a qualified low-income family. If you rent that next unit to a market-rate tenant by mistake, the IRS retroactively disallows credits for the over-income unit.

Special Section: Casualty Loss (Fire & Storms)

Relevant for post-disaster Hawaii.

If a unit is destroyed by a fire or hurricane (like the Lahaina tragedy), does it trigger an 8823? Yes.

• The Good News: The IRS gives you a “Reasonable Restoration Period” (often 24 months) to rebuild. During this time, you do not lose credits, provided you report it correctly.
• The Bad News: If you fail to restore the unit by the deadline, the IRS will recapture all credits claiming back to the date of the fire.

How to “Cure” a Finding (The HAPI Method)

You received a “Notice of Non-Compliance.” The clock is ticking. What now?

1. Stop the Bleeding: If it is a rent overcharge, cut the check to the tenant today. Do not wait for the next billing cycle.
2. Retroactive Certifications: If a file is missing entirely, you must “reconstruct” it. Interview the tenant, get third-party verifications that cover the past dates, and build a “Self-Proving” file.
3. The “Memo to File”: If you cannot fix it (e.g., the tenant moved out), write a detailed memo explaining the error and the new policy you implemented to prevent it. This shows “Due Diligence” to the IRS.