IRS Publishes Revised Average Income Regulations For LIHTC
By Forrest Milder
6 min read
The IRS has published the long-awaited revisions to its average income test regulations for the Low Income Housing Tax Credit.
What’s the impact?
• The new rules eliminate the “cliff test” that troubled sponsors and investors.
• Projects may still have to back out units in pairs when computing the actual amount of the tax credit.
• The new rules provide great flexibility in changing the percentages associated with units and relocating tenants.
One of the requirements to qualify for the Section 42 LIHTC is that a project must meet the “low-income set-aside,” i.e., it must have at least a minimum number of units that are rent-restricted and occupied by individuals whose income is at or below certain percentage requirements. Prior to 2018 legislation, there were two tests—at least 20 percent of the units had to be occupied by tenants whose income was at or below 50 percent of area median income (AMI) (the “20/50” test), or 40 percent of the units had to be occupied by tenants whose income was at or below 60 percent of AMI (the “40/60” test).
As part of 2018 legislation, the Internal Revenue Code was amended to include an average income test (AIT) as an addition to the 20/50 and 40/60 tests of existing law. The AIT enables a project to have units whose tenants have income at or under a range of percentages, from 20 to 80 percent of AMI, as an alternative to the 20/50 and 40/60 tests.
In 2020, the IRS issued proposed regulations providing its interpretation of AIT, and these regulations were criticized.
You’ll remember that the three biggest complaints about the proposed regulations were (1) loss of even one below-60 percent unit could potentially cause the entire building to no longer qualify for credits; (2) once designated, a unit was locked into a specified percentage, regardless of tenant needs or applicable law, like the Americans with Disabilities Act (ADA); and (3) designation and correction deadlines meant that building owners might discover that they had failed the law’s requirements, but be unable to timely correct the failure. These concerns made many developers and investors reluctant to use the AIT.
In response, the IRS held a hearing and called for written submissions. Now, in October 2022, the IRS has published “Temporary and Permanent Regulations,” which modify the proposed AIT regulations and address these complaints.
Note that the bulk of the regulations are now final, although the regulations addressing record-keeping are temporary and may change.
• The final regulations call for the owner to first demonstrate that at least 40 percent of the units in the building are rent-restricted and average out to 60 percent of AMI, both as to designation and occupancy. If this test is satisfied, then (assuming all other Section 42 requirements are met) the building qualifies as a low-income building for Section 42 purposes. For example, a 100-unit building that has 40 40 percent units and 40 80 percent units could designate all 40 40 percent units, or 30 40 percent units and ten 80 percent units, or a broad range of other possibilities, and still qualify. Note that even if 20 of the 40 percent units went out of service, it would still be possible to pass this test with 20 40 percent units and 20 80 percent units.
• The credit that the building then generates is based on the portion of the designated units in the building that are occupied by qualifying tenants, provided the average income of all such units is not higher than 60 percent. So, for example, in the 100-unit building I described above, 80 percent of the units would qualify. There can still be adverse consequences if a below 60 percent unit becomes uninhabitable. If this causes the average of occupied units’ designations to be more than 60 percent, then an above 60 percent unit may have to be excluded from the computation in order to pass the test. For example, in our same 100-unit building, if a 40 percent unit became uninhabitable, then we would exclude an 80 percent unit from the computation, leaving us with 78 percent of the building qualifying. But note that (as described in the preceding paragraph) since we are still well over 40 percent of the units in the building meeting the 60 percent requirement, the building will not be at risk of losing its credits entirely.
• Tenants can be relocated without upsetting the average income test, where it is in accordance with one of the following: (1) guidance published by the IRS; (2) a housing agency’s published written policy that applies to all projects; (3) the ADA, Violence Against Women Act, Federal Housing Administration, the Rehabilitation Act of 1973, or any other state, federal, or local law or program that protects tenants and is designated by the IRS or the housing agency; (4) a tenant relocates and the income designations of the units are swapped; or (5) the owner redesignates units to restore compliance with the AIT percentage requirement.
• While units are normally designated before they are occupied, changes in designation must be made not later than the end of the taxable year.
• An example illustrates that a multiple-building 100 percent low-income project can pass the tests across the buildings, even if one of the buildings is above the 60 percent average.
• The temporary regulations provide that designations of units must be done annually in both (1) the books and records of the owner, and (2) notice to the agency, as specified by the agency. It is sufficient to simply note changes, if any, from the prior year. The housing agency can waive failure to comply with the record-keeping requirements for up to 180 days after the failure is discovered.
• In general, the final regulations apply to taxable years beginning after Dec. 31, 2022. There are rules for residential units in projects that were already occupied prior to the applicability date. For taxable years prior to 2023, taxpayers may rely on a “reasonable interpretation of the statute.” It’s also notable that the regulations provide a lot of deference to state agencies in interpreting and applying the rules.
While some had hoped that the IRS would not require the possible removal of a second unit in computing the credit once all the units had been designated, the new temporary and final regulations are a sensible approach to the problem, and the other changes are helpful in facilitating the implementation of the AIT.
