IRS Published Final Regulations on the Average Income Test (AIT)
On October 7, 2022, the IRS released the long-awaited final regulation (Treasury Regulation 1.42-19), the Average Income Test (AIT). It is a great relief to see that this final regulation is a substantive departure from the proposed regulation published in 2020, which included many problematic provisions.
What is the Average Income Test (AIT) again?
In 2018, a new minimum set-aside was created, the Average Income Minimum Set-aside. To meet the Average Income Minimum Set-Aside, 40% or more of the units in a project must have a designated income limit, and the average income limit for the LIHTC units does not exceed 60%. This option allows projects to have higher income limits as long as the average income limits for the low-income units do not exceed 60%. The creation of this AI set-aside addresses the housing needs of a previously underserved demographic, as many households have incomes above 60% but yet, are unable to afford market-rate units.
What did the Final Regulation Do?
Most notably, the final regulation stipulated that it is not required to include all low-income units in the project when determining AIT compliance. In the proposed regulation, a single out-of-compliance unit at 100% AIT project could cause the project to violate the of Average Income Test, which would have resulted in a dire tax credit loss for the Project. The requirements in the proposed regulation created a stark disparity in the consequences compared to the impact of non-compliance at a 40-60 or 20-50 project. The final regulation essentially eliminates the possibility that one single out-of-compliance unit at a 100% AIT project would cause the project to violate the AIT.
This final regulation removes the burdensome impact of non-compliance for Average Income Test (AIT) projects. Essentially, the new regulation removes the disparate and increased risk of credit loss that deterred investors and developers from making the AIT election. It provides more flexibility in maintaining compliance and aligns the AI Test requirements to be more consistent with the 20-50 and 40-60 Tests. It also provides much-needed clarity and formal guidance on defining a low-income unit used for AIT projects when determining a building’s Applicable Fraction. Further, it allows housing providers to accommodate better tenants needing to transfer under the Violence Against Women Act (VAWA), Fair Housing, and other Acts providing tenant protections.
The Highlights of IRS Treasury Regulation 1-42.19
- Clarified the requirements to meet initially and to continue to comply with the Average Income Test (AIT)
- It is not necessary to include all low-income units in the project when determining AIT compliance; AIT is met if a taxpayer-identified “qualified group” of 40% of the project’s units have income limit levels averaging 60% or less and if the units in the group, are rent-restricted and occupied by qualified households.
- Removed the mitigating actions that only permitted AIT non-compliance issues to be remedied if corrected within 60 days of the end of the taxable “failed” year.
- Made clear that the AIT cannot be permanently satisfied simply by meeting the AIT initially, regardless of any issues of non-compliance that could occur. The AIT must be met initially and must be met continually throughout the project’s compliance period.
- Set the definition of a low-income unit in an AIT project to determine a building’s applicable fraction.
- Allows for changes in unit designations:
- Per the Housing Finance Agencies’ procedures
- To accommodate tenants who need to transfer under VAWA, Fair Housing, and other Acts providing tenant protections.
- When a change in a unit’s designation is needed to bring a project into compliance.
- Amends the Next Available Unit Rule (1.42-15) to require that the next available market-rate unit that is being used to satisfy the NAUR be re-designated to an income limitation that will maintain compliance with the AIT instead of designating the unit the specific income limitation that applied to the over-income unit.
- Includes temporary regulations regarding the record-keeping and reporting of AIT unit designations to State Housing Finance Agencies.