Average Income Test Final Rule Appears to Facilitate Practical Implementation of the New Set-Aside in Housing Credit Developments

Today, the U.S. Department of the Treasury and the Internal Revenue Service published final and temporary regulations providing guidance on the Low Income Housing Tax Credit (Housing Credit) Average Income Test (AIT) minimum set-aside. The AIT rule’s publication was announced earlier this morning by the Biden-Harris Administration in a statement on its progress meeting goals set forth in the administration’s Housing Supply Action Plan. More information about that announcement and background on NCSHA’s involvement in advocating for the AIT can be found in a separate blog post issued earlier today.

The final rule closely adheres to recommendations in a comment letter NCSHA submitted to IRS and Treasury on the proposed rule published in late 2020. In its comments, NCSHA had objected to the approach taken by Treasury/IRS regarding what would constitute a violation of the AIT minimum set-aside, arguing it was inconsistent with Section 42 and with the other minimum set-asides, would negatively impact investor interest in AIT developments, and could be particularly problematic in cases of casualty loss. NCSHA also maintained that mitigating actions IRS and Treasury had proposed were insufficient to overcome the risk associated with the proposed rule’s unnecessarily high minimum set-aside standard. Additionally, NCSHA protested the proposed rule’s prohibition on modifying income designations within an AIT property, which we contended was also inconsistent with Section 42 and other IRS policies; conflicted with federal fair housing, accessibility, and other laws related to violence against women and relocation; and created barriers to using the Housing Credit with other federal housing programs and existing state policies that, in certain circumstances, require redesignation of units.

The final rule departs significantly from the proposed rule. The following are key takeaways from the final rule:

1. The AIT minimum set-aside is considered met as long as 40 percent of the units in the property have designations that average 60 percent or less of area median income (AMI) and the households living in those units meet the income designation for their respective units. In addition, all units comprising a property’s applicable fraction must also average 60 percent or less of AMI; however, should a household living in a unit be ineligible under the respective income designation of that unit, and the removal of that unit from the applicable fraction causes the average to exceed 60 percent of AMI across all low-income units, it does not result in a violation of the minimum set-aside as long as 40 percent of the units in the project have an average designation of 60 percent or less with households living in them that are in compliance with those designations. The rule no longer includes the mitigating actions included in the proposed rule because the change to the requirement to meet the minimum set-aside substantially reduces the risk assumed by the owner and investor, making them unnecessary.

2. Given the flexibility provided, the rule establishes a system under which an owner must keep records and report to the state agency on unit designation and their compliance with the rule. A taxpayer must identify (1) the units in the qualified group of units that satisfy the AIT minimum set-aside (at least 40 percent of total units) and (2) the units in the qualified group for purposes of the applicable fraction (all low-income units in the property on which eligible basis is based for purposes of receiving Credits). Temporary regulations included with these final regulations require that this be done by recording these identifications in the taxpayer’s books and records and communicating that information annually to the state Housing Credit agency. These records must be sufficient so that agencies may ensure accuracy of the project’s applicable fraction, satisfaction with the AIT set-aside, and compliance with all requirements of Section 42 and regulations. Unit designations would not be due by the end of the first year of the credit period as initially envisioned in the proposed rule, but rather by when the unit is first occupied as a low-income unit. Housing Credit agencies have the flexibility to determine when and how owners must communicate this information to the agency and have discretion on a case-by-case basis to waive compliance with these temporary regulations related to recordkeeping and reporting.

3. The final rule also provides flexibility so that owners may modify unit designations. Changes are allowed (1) in accordance with any procedures established by the IRS in the future; (2) in accordance with written policies and procedures the Housing Credit agency puts in place; (3) to ensure protections under the Americans with Disabilities Act of 1990, the Fair Housing Amendments Act of 1988, the Violence Against Women Act of 1994, the Rehabilitation Act of 1973, or any other state, federal, or local law intended to protect tenants; (4) to allow an income-qualified tenant to move to a different unit within the project keeping the same income limitation; and (5) to restore the average of no more than 60 percent of AMI as applied to either meeting the AIT minimum set-aside or the applicable fraction.

The final regulations apply to taxable years beginning after December 31, 2022. For taxable years prior to the application of these regulations, taxpayers may rely on a reasonable interpretation of the statute, thus do not need to adhere to the proposed rule.

Implementation of the Average Income Test final rule will be a major topic of the HFA-only Multifamily Development and Multifamily Asset Management and Compliance Meet-Ups at NCSHA’s upcoming Annual Conference and will be a focus of the January HFA Institute’s Housing Credit module, registration for which is available for all NCSHA members and nonmembers.