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HUD Inspector General Cracks Down on the Use of Residual Receipts

By D. Hara Sherman
June 2009
People: D. Hara Perkins

In September 2008, the United States Department of Housing and Urban Development (HUD) Office of the Inspector General (OIG) released an internal audit report, Audit 2008-KC-0007 (OIG Report), regarding the use of funds from project residual receipt reserve accounts (Residual Receipts). The OIG Report addresses the limited eligible uses of Residual Receipts by owners of “new regulation” projects (as explained below). OIG recommended that HUD ensure that projects found to have used Residual Receipts for ineligible purposes reimburse their Residual Receipts accounts with reserve for replacements or operating funds, unless doing so would negatively affect the project – even for projects where HUD regional and field offices authorized the use of Residual Receipts. The HUD Office of Housing has adopted and implemented this policy.

This policy is creating a problem as owners of aging properties seek to use their Residual Receipts to make their projects energy efficient.

HUD administrative procedures identify the eligible uses of Residual Receipts and require project owners to obtain HUD approval prior to expending Residual Receipts for any purpose. (HUD Handbook 4350.1, Chapter 25). The OIG report audited 14 projects all of which were “new regulation” projects. The OIG concludes for “new regulation” projects, Residual Receipts may be used only for two purposes, (i) to reduce operating deficits when legitimate cash flow deficits exist or (ii) to make mortgage payments when a mortgage default is actual or imminent – all other uses of Residual Receipts in “new regulation” projects are to be disapproved by the field offices. The OIG Report specifically states that for “new regulation” projects, Residual Receipts may not be used in lieu of reserve for replacement funds for capital expenditures or operating costs, including expenses for painting, management fees, kitchen renovations, installing slate over new concrete walkways, repairs to elevators or window replacements. The uses for Residual Receipts in “new regulation” projects were developed at a time when the “new regulation” projects were newly constructed and not in need of major capital improvements.

The above referenced OIG report and the Office of Housing adoption of the OIG management recommendations contained in the report, take the position that Residual Receipts may be used only for the two purposes described above.  This determination is administrative policy, and is not required by law or statute.  In fact, HUD Handbook 4350.1, Chapter 25-11 provides that the Assistant Secretary for Housing or the Federal Housing Commissioner may allow “new regulation” projects to use Residual Receipts for “other project purposes.”   The standard form of housing assistance payment (HAP) contract for a Section 8 property also provides that Residual Receipts may be used for “other project purposes.”  Further, HUD regulations at 24 CFR 880.205 and 24 CFR 881.205 provide that excess funds, such as residual receipts maybe be used for “other project purposes”. The position of the new Administration on this issue is not known, and it is also not known how a change in this policy would impact the Inspector General position.  Congressional action could resolve the issue. It is noted that for “old regulation” projects, the eligible uses of Residual Receipts are broader, including, but not limited to: (i) reduction of operating deficits; (ii) making mortgage payments when a mortgage default is actual or imminent; (iii) making necessary repairs not covered by the reserve fund for replacements; (iv) providing additional project amenities (such as energy saving devices); (v) paying accrued distributions where allowable; (vi) repaying HUD residual receipts notes; (vii) repaying Flexible Subsidy Operating Assistance or Capital Improvement Loans; (viii) making enhancements for fair housing purposes; or (ix) testing for or the abatement of lead-based paint.

By way of background, in 1979/1980, HUD changed the regulations controlling the use of Residual Receipts.  Section 8 projects that received a HAP notice of selection before the change are referred to as “old regulation” projects and properties that received the notice of selection after the change are “new regulation” projects.  For “old regulation” projects, Residual Receipts are released to the property owner when the regulatory agreement terminates.   “New regulation” project owners are required to transfer the Residual Receipts to HUD upon termination of the regulatory agreement.  When the HAP contract for a Section 8 property expires, the property’s Residual Receipts either belong to HUD or the property owner, depending on when the property received its HAP notice of selection.  In either case, the use of Residual Receipts prior to the HAP contract’s expiration is subject to HUD’s control.

If you have questions regarding the use of Residual Receipts, or potential issues stemming from past use of Residual

This advisory should not be construed as legal advice or legal opinion on any specific facts or circumstances. The
contents are intended for general informational purposes only, and you are urged to consult your own lawyer concerning your situation and any specific legal questions you may have.

Pursuant to IRS Circular 230, please be advised that, this communication is not intended to be, was not written to be and cannot be used by any taxpayer for the purpose of (i) avoiding penalties under U.S. federal tax law or (ii) promoting, marketing or recommending to another taxpayer any transaction or matter addressed herein.

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