On October 7, 2022, the IRS released the long-awaited final regulations on the use of income averaging as a minimum set aside option for low-income housing projects. The issuance comes after much urging from the affordable housing industry to revisit the proposed regulations released in October 2020 that quickly quieted any industry interest in using this third minimum set-aside option.

In general, the final regulations prove much more favorable for the industry and are more reflective of Congress’ original intent to provide more affordable housing supply and diversity across the country. Moreover, this additional minimum set aside option gives the industry more flexibility in handling market demands.

In summary, the average income minimum set aside allows a project to qualify as a low-income housing project if at least 40% of the project units (25% in the case of projects under IRC Section 142(d)(6)) are leased to tenants with an average of no more than 60% of the area median gross income (AMGI). The prescribed income limits for units can be 20%, 30%, 40%, 50%, 60%, 70%, or 80% of AMGI as long as the average is 60% of AMGI or less. Additionally, the units must be “pre-designated”.

The proposed regulations’ interpretation of the average income test had created much concern surrounding what was known as a “cliff test” related to noncompliance. Under the previous interpretation, the project’s 60% AMGI average calculation was to be based on all low-income units versus a smaller subset of units, which, depending on unit composition, could cause a building and/or project to fail the minimum set aside and therefore, lose low-income status.

Fortunately, the final regulations remove this “cliff test” and instead allow for the minimum set aside to be met as long as a qualified group of units constituting 40% or more of the units in the project are at 60% or less of AMGI. As such, the status of low-income units beyond this qualified group of units needed to meet the minimum set aside will not affect the overall ability to meet the average income test.

Further, projects are now allowed to identify another group of units when calculating the applicable fraction. The applicable fraction calculation must include the qualified group of units selected for minimum set aside but can also include additional units as long as the entire group averages 60% or less of AMGI.

Other pertinent highlights of the final regulations include:

• Removal of a specific order in applying the next available unit rule with respect to occupancy
• Initial designations of units are now required when a unit is first occupied instead of at the end of the first credit period of the project as was originally noted in the proposed regulations. This allows for more flexibility in meeting market demands.
• Designations must be noted in the books and records of the project and communicated to the applicable housing agencies on an annual basis.
• Changes in unit income limit designations are allowed when directed by the IRS or housing agency, for ADA compliance purposes, to meet tenant transfer requests and to restore the average income limit to satisfy the minimum set aside or applicable fraction percentages.

Under this minimum set aside option, it’s also important to note that in the event of a casualty or other situation that causes one or more units to become uninhabitable/lose low income status, more than the affected unit(s) could actually experience a loss of credits in order to maintain the average of 60% or less AMGI. For example, a 100% low income building includes 50% of the units at 80% AMGI and 50% at 40% AMGI. One of the 40% units becomes uninhabitable. As such, the building no longer meets the 60% or less AMGI average for the applicable fraction unless an 80% AMGI unit is also removed from the calculation. This would result in 2 units losing credits instead of just the 1 uninhabitable unit.

Overall, the final regulations are a welcome change to those proposed two years ago and will garner more interest and support among the affordable housing community. Those projects electing the average income minimum set aside will no doubt need a robust compliance team and heavy monitoring over leasing and tenant activity.

For more information on these regulations, please contact a member of your RubinBrown team.

 

^{Readers should not act upon information presented without individual professional consultation.}