AJJCS
Products News Help
Client Sign In

IRS Notice of Proposed Rulemaking on Average Income Test

person A.J. Johnson today 11/01/2020

On October 30, the IRS published a Notice of Proposed Rulemaking in the Federal Register. This Notice concerns the LIHTC Average Income Test and outlines the current intention of the IRS with regard to certain rules governing the Average Income (AI) test.

Written comments regarding the proposed rules must be received at the IRS no later than December 29, 2020.

Background

Section 42(g)(1)(C)(i) enunciates the requirement of the AI set-aside, stating that a project meets the minimum requirements of the average income test if 40 percent or more (25 percent in New York City) of the residential units in the project are both rent-restricted and occupied by tenants whose income does not exceed the imputed income limitation designated by the owner with respect to the respective unit. The owner must designate the imputed income limitation for each unit and the designated imputed income limitation of any unit must be 20, 30, 40, 50, 60, 70, or 80 percent of AMGI. The Code provides that the average of the imputed income limitations designated by the taxpayer (i.e., owner) for each unit must not exceed 60 percent of AMGI.

Section 42(g)(2)(D)(iii) was added to the Code to provide a new next available unit (NAU) rule for situations in which the owner has elected the AI test. Under this new NAU rule, a unit ceases to be a low-income unit if two conditions are met: (1) the income of an occupant of a low-income unit increases above 140% of the greater of (i) 60% of AMGI, or (ii) the imputed income limitation designated by the owner with respect to the unit; and (2) any other residential rental unit in the building that is of a size comparable to, or smaller than, that unit is occupied by a new tenant whose income exceeds the applicable imputed income limitation. If the new tenant occupies a unit that was taken into account as a low-income unit prior to becoming vacant, the applicable imputed income limitation is the limitation designated with respect to the unit. If the new tenant occupies a market-rate unit, the applicable imputed income limitation is the limitation that would have to be designated with respect to the unit in order for the project to continue to maintain an average of the designations of 60% of AMGI or lower.

Under §42(g), once a taxpayer elects to use a particular set-aside test with respect to a low-income housing project, that election is irrevocable. Thus, if a taxpayer had previously elected to use the 20/50 or 40/60 test, the taxpayer may not subsequently elect to use the AI test.

Explanation of Provisions

  1. Proposed §1.42-15, Next Available Unit Rule for the Average Income Test
    1. The proposed regulations update the NAU provisions in §1.42.15. In situations where multiple units are over-income at the same time in an AI project that has a mix of low-income and market-rate units, these regulations provide that the owner need not comply with the NAU rule in a specific order. Renting any available comparable or smaller vacant unit to a qualified tenant maintains the status of all over-income units as low-income units until the next comparable or smaller unit becomes available. E.g., in a 20-unit building with nine low-income units (three units at 80% of AMGI, two units at 70% of AMGI, one unit at 40% of AMGI, and three units at 80% of AMGI), if there are two over-income units, one a 30% income three-bedroom unit and another a 70% two-bedroom unit, and the NAU is a vacant two-bedroom market-rate unit, renting the vacant two-bedroom unit to occupants at either the 30 or 70 percent income limitation would satisfy both the minimum set-aside of 40% and the average test of 60% or lower. This will be the case even if the 30% unit was the first unit to exceed the 140% income level.
  2. Proposed §1.42-19, Average Income Test
    1. Designation of Imputed Income Limitations: The proposed regulations provide that a taxpayer must designate the imputed income limitation of each unit taken into account under the AI test in accordance with (1) any procedures established by the IRS; and (2) any procedures established by the Agency that has jurisdiction over the LIHTC project that contains the units to be designated, to the extent that those Agency procedures are consistent with any IRS guidance and the proposed regulations. The IRS does agree that Agencies should generally be able to establish designation procedures that accommodate their needs. Agencies will be permitted to require income recertifications, set compliance testing periods, and adjust compliance monitoring fees to reflect the additional costs associated with monitoring the AI test.
  3. Method and Timing of Unit Designation
    1. Designation of the AI limitation with respect to a unit is, first, for Agencies to evaluate the proper mix of units in a project in making housing credit dollar amount allocations consistent with the state policies and procedures set forth in the QAP, and second, to carry out their compliance-monitoring responsibilities.
    2. The proposed regulation requires that taxpayers designate the units in accordance with the Agency procedures relating to such designations, provide that the Agency procedures are consistent with any requirements and procedures relating to unit designation that the IRS may require.
    3. The proposed regulations provide that the taxpayer must complete the initial designation of all the units included in the AI test as of the close of the first taxable year of the credit period.
    4. The proposed regulations provide that no change to the designated income limitations may be made. Based on this, it does not appear that the "floating" of units would be permitted. This will be problematic from a project operational standpoint and should be objected to in comments submitted to the IRS.
  4. Requirement to Maintain 60 Percent AMGI Average Test and Opportunity to Take Mitigating Actions
    1. For a project electing the AI test, in addition to the project containing at least 40% low-income units, the designated imputed income limitations of the project must meet the requirement of an average test. That is, the average of the designated imputed income limitations of all low-income units (including units in excess of the minimum 40% set-aside) must be 60 percent of AMGI or lower. Residential units that are not included in the computation of the average (i.e., market units) do not count as low-income units. Accordingly, in each taxable year, the average of all the designations must be 60% of AMGI or lower.
    2. In some situations, the AI requirement may magnify the adverse consequences of a single unit’s failure to maintain its status as a low-income unit (this is a reference to the "cliff test" fear). Assume, for example, a 100% low-income project in which a single unit is taken out of service. Under the 20/50 or 40/60 set-asides, the project remains a qualified low-income housing project even though the reduction in qualified basis may trigger a corresponding amount of recapture. However, under the AI set-aside, if the failing unit has a designated imputed income limitation that is 60% or less of AMGI, the average of the limitations without that unit may now be more than 60%. In the absence of some relief provision under the AI test, the entire project would fail, and the taxpayer would experience a large recapture.
    3. Because there is no indication that Congress intended such a stark disparity between the AI set-aside and the existing 20/50 and 40/60 set-asides, the proposed regulations provide for certain mitigating actions. If the taxpayer takes a mitigating action within 60 days of the close of a year for which the AI test might be violated, to taxpayer avoids total disqualification of the project and significantly reduces the amount of recapture.
  5. Results Following an Opportunity to Take Mitigating Actions
    1. The proposed regulations provide that, after any mitigating actions, if, prior to the end of the 60th day following the year in which the project would otherwise fail the 60% test, the project satisfies all other requirements to be a qualified low-income housing project, then as a result of the mitigating action, the project is treated as having satisfied the 60% or lower average test at the close of the immediately preceding year. However, if no mitigating actions are taken, the project fails to be a qualified low-income housing project as of the close of the year in which the project fails the AI test.
  6. Descriptions of Mitigating Actions
    1. The proposed regulations provide for two possible mitigating actions: (1) the taxpayer may convert one or more market-rate units to low-income units. Immediately prior to becoming a low-income unit, that unit must be vacant or occupied by a tenant who qualifies for residence in a low-income unit (or units) and whose income is not greater than the new imputed income limitation of that unit (or units); or (2) the taxpayer may identify one or more low-income units as "removed" units. A unit may be a removed unit only if it complies with all the requirements of Section 42 to be a low-income unit. If the taxpayer elects to identify a low-income unit as a removed unit, the designated imputed income limitation of the unit is not changed.
  7. Tax Treatment of Removed Units
    1. A removed unit is not included in computing the average of the imputed income limitations of the low-income units under the 60% or lower AI test. If the absence of one or more removed units from the computation causes fewer than 40% (or 25% in New York City) of the residential units to be taken into account in computing the average, the project fails to be a qualified low-income housing project. I.e., the project fails the minimum set-aside test. Also, a removed unit is not treated as a low-income unit for purposes of credit calculation. However, a removed unit will not be subject to recapture (unless the removal of the unit results in a failure to meet the minimum set-aside).
  8. Request for Comments on an Alternative Mitigating Action Approach
    1. This is the one area of the proposed regulation for which the IRS is especially interested in receiving comments. The alternative being proposed by the IRS is that, in the event that the average test rises above 60% of AMGI as of the close of a taxable year, due to a low-income unit or units ceasing to be treated as a low-income unit or units, the owner may take the mitigating action of redesignating the imputed income limit of a low-income unit to return the average test to 60% of AMGI or lower. If under this approach, a redesignation causes a low-income unit to exceed 140% of the applicable income limit, the NAU would apply.

Proposed Applicability Date

The amendments to the NAU regulation (1.42-15) are proposed to apply to occupancy beginning 60 or more days after the date the regulations are published as final regulations. The AI test regulations (1.42-19) are proposed to apply to taxable years beginning after the date the regulations are published as final regulations. However, taxpayers may rely on these proposed regulations relating to the NAU rule for occupancy beginning after October 30, 2020, and on or before 60 days after the date, the regulations are published as a final regulation. Taxpayers may also rely on the AI test proposed regulations for taxable years beginning after October 30, 2020, and on or before the date those regulations are published as final regulations.

Summary

These proposed regulations do provide some clarity relating to the Available Unit Rule and assist in our understanding that the IRS does not believe a project should lose all credit due to the failure of one unit as a low-income unit (unless the minimum set-aside is not met). However, a significant problem with the proposed regulation is that designations, once set, cannot be changed. The industry will certainly be objecting to this provision during the 60-day comment period. There is one other area on which clarity should be sought. All the mitigation examples in the proposed regulation include a case where a unit is lost due to no longer being suitable for occupancy. Left unanswered is what happens if a low-income unit is occupied by an ineligible household. Does the fact that the owner designation for the unit still results in the 60% AI test being met keep the property in compliance with the 60% test result in the loss of only that one unit with no requirement for mitigation measures? Or, would this unit also no longer be considered a low-income unit for purposes of the 60% average? Also, what if the issue that would remove a unit from the low-income count occurs in one year, is not discovered by the owner, and is discovered by the State Agency during a review that occurs more than 60 days after the end of the tax year in which the event occurred? While this could not happen in the case of a habitability issue, it could certainly occur relative to resident eligibility.  Comments seeking clarity on the circumstances under which a unit may no longer be counted toward the 60% average are a certainty. Until this issue is clarified, the safest course of action for owners will be to follow the mitigation alternatives outlined in the proposed regulation in any case where a low-income unit is either not in service or rented to an ineligible household.

It is recommended that all LIHTC industry participants review the proposed regulations and make comments to the IRS by the deadline date of December 29, 2020.

Latest Articles

HUD Publishes 2025 Income Limits

On April 1, 2025, HUD published the 2025 income limits for HUD programs and the Low-Income Housing Tax Credit and Tax-Exempt Bond programs. The limits are effective on April 1, 2025. The limits for the LIHTC and Bond projects are published separately from those for HUD programs. For better understanding, LIHTC and Bond properties operate under the Multifamily Tax Subsidy Project (MTSP) limits. These properties are 'held harmless' from income limit (and therefore rent) reductions. This means that these properties may use the highest income limits for resident qualification and rent calculation since the project has been in service. However, it's important to note that HUD program income limits are not 'held harmless '. HUD publishes the 50% and 60% MTSP limits alongside the Average Income (AI) limits, which are set at 20%, 30%, 40%, 50%, 60%, 70%, and 80%. Projects that began service before 2009 may utilize the HERA Special Income Limits in areas where HUD has published such limits. Projects placed in service after 2008 cannot use the HERA Special Limits. Projects in rural areas not financed by tax-exempt bonds can use the higher MTSP limits or the National Non-Metropolitan Income Limits (NNMIL). It is important to note that for 2025, HUD has made changes to the definitions of geographic areas as determined by the Office of Management and Budget (OMB). The counties or towns within certain metropolitan areas may have changed. Owners and managers should consult the HUD Area Definition Report for a list of their areas and their components. The link to the Area Definition Report can be found on the website provided below. Owners of LIHTC projects may rely on the 2024 income limits for all purposes for 45 days after the effective date of the newly issued limits, which ends on May 16, 2025. The limits for HUD programs may be found at www.huduser.gov/portal/datasets/il.html. The limits for LIHTC and Bond programs may be found at www.huduser.gov/portal/datasets/mtsp.html.

Read full story

Effects of Potential Staffing Cuts on HUD Programs

As the Trump administration moves forward with plans to reduce the federal workforce dramatically, the Department of Housing and Urban Development (HUD), according to recent reporting by the Associated Press, could face potential cuts that could eliminate half of its staff approximately 4,000 positions. Widespread Impact Across Essential Services The proposed reductions would affect numerous critical HUD programs, including disaster recovery efforts, rental assistance, housing discrimination investigations, and support for first-time homebuyers. Housing advocates and former HUD officials have raised substantial concerns that these extensive staffing cuts could greatly hinder or even stop the department s ability to carry out its mission. The official HUD position is that this information "should not be considered final. However, the potential extent of these reductions aligns with the administration s broader goal of reducing government spending. Recently appointed HUD Secretary Scott Turner announced the formation of a Department of Government Efficiency task force inspired by billionaire Elon Musk, while also underscoring the identification of "$1.9 billion in misplaced funds and "$260 million in wasteful contracts. Rental Assistance Programs at Risk The proposed cuts most concerning aspect is their potential impact on the Office of Public and Indian Housing, which could lose half its workforce from 1,529 employees to just 765. This office manages rental assistance subsidies for more than 3.5 million households and supports public housing for approximately 1 million people. Georgi Banna, general counsel for the National Association of Housing and Redevelopment Officials, warns that such reductions could delay payments for the Section 8 voucher program, which provides rental assistance to millions of low-income Americans. Although tenants have certain protections as long as they pay their share of the rent, they could ultimately face displacement if landlords withdraw from the voucher program due to payment issues. Budget Challenges Compound the Problem The potential staffing cuts come at a particularly challenging time as Congress continues to navigate a contentious appropriations process for HUD programs. The House version of the spending bill would boost funding for Housing Choice Vouchers by $115 million, which sounds promising but falls far short of the estimated $4.3 billion increase needed to simply maintain current service levels, according to the Center on Budget and Policy Priorities (CBPP). If the House budget is approved, it will only meet 90% of the need, potentially causing about 283,000 households to lose voucher access what the CBPP has described as the "most severe funding shortfall in the history of the voucher program. The situation has already caused damage, with some voucher-administering agencies halting the distribution of new vouchers. Local housing authorities have been operating on constrained budgets, and many lack robust reserves to weather a potential government shutdown or significant funding cuts. Fair Housing Enforcement Under Threat Perhaps the most alarming aspect is the proposed 77% reduction in the Office of Fair Housing and Equal Opportunity, which could shrink its staff from 572 employees to only 134. As HUD s main enforcer of national fair housing laws, this office investigates discrimination complaints and works to ensure equal access to housing. Although Secretary Turner has previously committed to upholding the Fair Housing Act, which includes a statutory mandate for HUD to combat discrimination, the administration s approach to implementing the law may undergo significant changes. Turner recently announced on social media that HUD had canceled $4 million in diversity, equity, and inclusion contracts. Uncertainty for Housing Authorities and Vulnerable Populations Potential staffing cuts and budget uncertainties have come together to create a tumultuous situation for local housing authorities. Housing authorities are finding it difficult to provide clear guidance to both families and landlords while anticipating potentially "draconian consequences if significant cuts or a government shutdown happen. The months ahead may pose unprecedented challenges and uncertainty for millions of Americans relying on HUD programs for stable housing, especially those using Section 8 vouchers. As Congress decides whether to pass a bill keeping the government open, the future of these critical housing programs and the millions of Americans who rely on them hangs in the balance. In conclusion, the proposed staffing cuts at HUD pose a significant threat to the stability and effectiveness of critical housing programs that serve millions of Americans. If carried out, these reductions could disrupt essential services like rental assistance, fair housing enforcement, and disaster recovery putting vulnerable populations at greater risk of housing instability and discrimination. The potential for delayed payments, reduced voucher access, and weakened fair housing protections highlights the profound human impact of these cuts. As Congress deliberates over HUD s budget, the stakes could not be higher for the families, landlords, and housing authorities that rely on these programs for their survival and stability. The coming months will challenge the resilience of HUD s mission and the nation s commitment to providing safe, fair, and affordable housing for all. All those in the affordable housing industry must reach out to their elected representatives to stress the importance of HUD and its programs to the housing needs of America s most vulnerable populations.

Read full story

A. J. Johnson Partners with Mid-Atlantic AHMA for December Training on Affordable Housing—April 2025

In April 2025, A. J. Johnson will partner with the MidAtlantic Affordable Housing Management Association for four live webinar training sessions for real estate professionals, particularly those in the affordable multifamily housing field. The following sessions will be presented: April 15: Pets/Pot/Service Animals: Navigating Fair Housing A Comprehensive 90-Minute Webinar for Housing Professionals Join us for an essential training session that tackles three of the most challenging areas in fair housing compliance today. This practical webinar will equip affordable housing providers with clear guidance on: Service and Emotional Support Animals: Learn the crucial legal distinctions between pets and assistance animals, proper verification procedures, and how to handle accommodation requests while complying with FHA regulations. Pet Policy Development: Explore effective strategies for creating and enforcing fair pet policies that address resident needs while considering property management concerns. Medical Marijuana Considerations: Explore the intricate relationship between federal and state laws concerning medical marijuana use in housing, including the requirements for reasonable accommodation. Through case studies, interactive discussions, and expert analysis of recent court decisions, you will gain actionable strategies for confidently addressing these challenging issues. This tool is perfect for property managers, leasing agents, compliance officers, and housing administrators who want to minimize legal risk while creating inclusive communities. April 16: VAWA with Tips on Communicating with Victims - The Violence Against Women (VAWA) Reauthorization Act of 2013 expanded VAWA protections to many different affordable housing programs, including the Low-Income Housing Tax Credit (LIHTC) Program. While HUD has provided detailed requirements on VAWA implementation at HUD properties, there has been no uniform guidance for LIHTC owners and managers. A proposal before Congress would legislate that LIHTC Extended Use Agreements contain VAWA requirements. The IRS has not provided guidance, and while many state agencies are requiring VAWA plans, they are not providing information on what the plans should look like. This two-hour training, when combined with the course materials, will review VAWA requirements and recommend best practices for developing VAWA plans at LIHTC and other non-HUD properties. The session will be presented by A. J. Johnson, a recognized expert in the affordable housing field and the author of "A Property Manager s Guide to the Violence Against Women Act. April 24: Preparation for Physical Inspections - Agency inspections of affordable housing properties are required for all affordable housing programs, and failure to meet the required inspection standards can result in significant financial and administrative penalties for property owners. This four-hour training focuses on how owners and managers may prepare for such inspections, with a concentration on HUD NSPIRE inspections and State Housing Finance Agency inspections for the LIHTC program. Specific training areas include (1) a complete discussion of the most serious violations, including health & safety; (2) how vacant units are addressed during inspections; (3) when violations will be reported to the IRS; (4) the 20 most common deficiencies; (5) how to prepare a property for an inspection; (6) strategies for successful inspections; and (7) a review of the most important NSPIRE Standards as they relate to the three inspectable areas [Units/Interior/Exterior]. The training will summarize the HUD Final Rule on NSPIRE with a discussion of (1) the new Self-Inspection Requirement and Reports; (2) Timeline for Deficiency Correction; (3) New Affirmative Requirements; and (4) Tenant Involvement. At the end of the training, attendees will have a blueprint they can use to prepare their properties for agency-required physical inspections, regardless of the program under which they operate. April 29: Understanding and Managing Hoarding in Residential Properties: A Fair Housing Compliance Workshop - In May 2013, the American Psychiatric Association (APA) confirmed that Compulsive Hoarding is a mental disability and a protected class. More than 15 million Americans suffer from the mental health problem of hoarding and potential problems from hoarding include noxious odors, pest infestation, mold growth, increased risk of injury or disease, fire hazards and even structural damage. Hoarding is the one class of disability that requires landlords to offer an accommodation even if an accommodation is not requested! This 1.5-hour live webinar is designed to assist multifamily managers in understanding how to deal with hoarding problems in a way that will prevent liability under fair housing law. The session will define hoarding and provide detailed recommendations on how to deal with a hoarding problem. It will outline examples of accommodations for hoarding, how to engage in the "interactive process with residents who hoard, and the steps necessary to remove uncooperative residents. Finally, a recent court case regarding hoarding will be reviewed as an illustration of the potential difficulties managers face in hoarding situations. This is an evolving area of fair housing law, and this webinar will provide the guidance necessary to approach the problem in a systematic way that will give multifamily operators the best chance at avoiding the legal traps that exist when dealing with this unique disability. These sessions are part of the year-long collaboration between A. J. Johnson and MidAtlantic AHMA and are designed to provide affordable housing professionals with the knowledge to effectively manage the complex requirements of the various agencies overseeing these programs. Persons interested in any (or all) training sessions may register by visiting either www.ajjcs.net or https://www.mid-atlanticahma.org.

Read full story

Impact of Trump Administration's Regulatory Restructuring on HUD and IRS

The Trump administration's recent executive order on federal regulations, "Ensuring Lawful Governance and Implementing the President's 'Department of Government Efficiency' Deregulatory Initiative," signals significant changes for federal agencies. The order has particularly notable implications for the Department of Housing and Urban Development (HUD) and the Internal Revenue Service (IRS). The New Regulatory Framework On February 19, 2025, President Trump signed this executive order as part of a broader deregulatory agenda aimed at reducing what the administration views as bureaucratic overreach. The directive mandates that federal agencies conduct a comprehensive 60-day review of their regulatory frameworks to ensure alignment with both legal requirements and administration policies. The order targets explicitly regulations considered: Unconstitutional Based on improper delegations of legislative power Imposing excessive costs without clear public benefits Harmful to national interests Hindering development across various sectors This order is part of a series of regulatory rollbacks, including directives like "Ensuring Accountability for All Agencies" and "Unleashing Prosperity Through Deregulation," which expand upon the administration's previous deregulatory efforts. Specific Impacts on the IRS The IRS faces several significant challenges under this new directive: Continued Hiring Freeze: The executive order maintains an existing hiring freeze at the IRS, which will remain in effect until the Treasury Secretary, in consultation with the Office of Management and Budget (OMB) Director, determines that lifting it serves the national interest. Increased White House Oversight: IRS regulations will once again be subject to White House review through the Office of Information and Regulatory Affairs (OIRA), reinstating a policy from Trump's first term that adds another layer of scrutiny to IRS rulemaking. "10-for-1" Deregulation Mandate: The IRS must eliminate ten existing guidance documents for every new rule or guidance it issues, significantly constraining its ability to update tax regulations and provide new guidance. These measures could substantially impact the IRS's capacity to uphold compliance and maintain operational efficiency, potentially affecting tax administration and enforcement nationwide. Implications for HUD For the Department of Housing and Urban Development, the executive order brings equally significant changes: Comprehensive Program Review: The order requires a review of hundreds of HUD programs, potentially leading to significant restructuring or budget cuts. Grant Funding Uncertainty: Although a federal court temporarily blocked a separate memo seeking to freeze federal grants, the administration's intent to reassess HUD funding remains evident. "10-for-1" Rule Application: Like the IRS, HUD must adhere to the requirement of eliminating ten existing regulations for every new one proposed, which could significantly impact housing policy implementation and program management. These changes may affect HUD's ability to administer housing assistance programs, enforce fair housing regulations, and support community development initiatives. Legal and Procedural Challenges The administration's deregulatory push faces potential legal obstacles: Agencies seeking to rescind or modify rules must generally follow a new rulemaking process, including issuing a Notice of Proposed Rulemaking, collecting public comments, and finalizing the new rule. Failure to adhere to these procedural requirements could expose regulatory rollbacks to legal challenges under the Administrative Procedure Act (APA). The APA requires agencies to engage in reasoned decision-making when modifying or rescinding regulations, and courts may overturn agency decisions if this standard is not met. Outlook As the 60-day review period progresses, the IRS and HUD must navigate competing demands: implementing the administration's deregulatory agenda while maintaining their core functions and avoiding legal challenges. The outcome will likely reshape how these agencies operate and could have lasting implications for the United States s tax administration and housing policy. The full impact of these changes will become more evident as agencies determine which regulations to target and how to implement the administration's directives while fulfilling their statutory obligations.

Read full story

Want news delivered to your inbox?

Subscribe to our news articles to stay up to date.

We care about the protection of your data. Read our Privacy Policy.