I posted an article on March 24, 2018, describing the two changes made to the Low-Income Housing Tax Credit (LIHTC) program by the "Consolidated Appropriations Act, 2018," the increase in credits and the new "Average Income Test." I want to provide some additional guidance regarding the Average Income Test, including how that test will impact the Available Unit Rule and Deep Rent Skewed Projects.
The "actual" income of a household will not be used in determining whether the average of the imputed income limitations is 60% or less. The determination will be made based on the designated imputed income limitation of each individual low-income unit. As noted in my earlier memo, units will be designated using 10-percent increments (20%, 30%, 40%, 50%, 60%, and 70%). For example, if the 50% income limit for an area is $35,500, the 20% income limit for the area is $14,200. If the income of a household is $14,200, it may be designated as a 20% unit; if the income of the household is $10,000, it is still a 20% unit. In other words, a lower income household provides no greater benefit when calculating the average of area median gross income than a household at the maximum limit of any particular unit designation (e.g., 20% units).
Let’s take a look at how this determination will work.
Assume a one-building project with a ten-unit building (all units the same size) with the following unit designations:
UnitDesignated Income Limit
1 60%
2 40%
3 80%
4 60%
5 80%
6 30%
7 60%
8 60%
9 50%
10 80%
The average of the imputed income limitations in this case is 60% and all units would be LIHTC eligible, including the 80% units.
But, change the unit designation of Unit 6 from 30% to 40% and the average of the imputed income limitations is 61% and the 80% units are no longer LIHTC eligible. These three units would be considered market units and instead of an applicable fraction of 100%, the applicable fraction would be 70%. If the building’s eligible basis is $800,000, the qualified basis will decrease from $800,000 to $560,000. If the building is entitled to a 9% credit, the annual credit will decrease from $72,000 to $50,400. If the designation of Unit 6 changed from 30% to 40% after the first year of the credit period, in addition to the $21,600 reduction in annual credits, the building would also face recapture on credits that were claimed in the years prior to the noncompliance year on the three 80% units.
This scenario raises an additional question. Since the average of the imputed income limitations exceeds 60%, is the minimum set-aside met, and is the project entitled to any credits? Based on the exact wording in the new law ("The project meets the minimum requirements of this subparagraph if 40 percent or more [25 percent or more in the case of a project described in section 142(d)(6)] of the residential units in such project are both rent-restricted and occupied by individuals whose income does not exceed the imputed income limitation designated by the taxpayer with respect to the respective unit"), it is my opinion that the project would still be tax credit eligible. This is because while the average of the low-income units exceeds 60% of AMGI, 40% or more of the units still meet the imputed income limitation designated by the taxpayer.
Clearly, owners electing the new average income test will be required to carefully track the status of each unit in the project to ensure that the required 60% average is met at all times.
Impact on the Available Unit Rule (AUR)
If the owner elects the Average Income Test, and the income of the occupants of a unit increase above 140% of the greater of -
60% of area median gross income, or
the imputed income limitation designated with respect to the unit in which the increase in income has occurred,
the unit will no longer be considered a low-income unit if any unit in the building (or a size comparable to, or smaller than such unit) is occupied by a new resident whose income exceeds the income limit designation that the newly occupied unit had prior to becoming vacant (if the newly vacated unit was a qualified low-income unit), and the imputed income limit which would have to be designated for the vacated unit in order for the project to meet the requirements of the Average Income Test.
Example #1 (All units the same size)UnitDesignated Income Limit
1 60%
2 40%
3 80%
4 60%
5 80%
6 30%
7 60%
8 60%
9 50%
10 Market
Assume a 60% income limit of $42,600. 140% of this limit is $59,640.
The average income of the imputed income limitations for the low-income units is 57.78% of the area median gross income so this qualifies as a low-income project.
The household in unit 2 recertifies with income of $39,800. While this exceeds 140% of the 40% income limit of $28,400, it does not exceed 140% of the 60% limit; therefore, the AUR does not apply to the building. If the market unit is vacated, it may be rented to another market resident.
However, if the household in Unit 2 recertifies with income of $60,000, the income now exceeds 140% of the 60% income limit and the AUR is in play. When Unit 10 is vacated, the new household must qualify at an income level that will enable to project to meet the Average Income Test and Unit 2 will be considered a market unit. If Unit 10 is rented to a household at the 60% income level, the building configuration is as follows:
UnitDesignated Income Limit
1 60%
2 Market
3 80%
4 60%
5 80%
6 30%
7 60%
8 60%
9 50%
10 60%
The average income of the imputed income limitations for the low-income units is 60% of the area median gross income so the project continues to qualify as a low-income project. This is the case even though a 40% unit was replaced with a 60% unit. However, if a household occupied Unit 10 with income above the 60% level, the average income test would not be met and both Units 2 and 10 would be considered market units, violating the AUR and lowering the building’s applicable fraction from 90% to 80%.
It is important to note that other low-income units are not affected by a household that becomes over-income, and may continue to be rented at the imputed income level originally used when qualifying the building. For example, in the scenario described above, if Unit 5 is vacated instead of Unit 10, unit 5 may still be rented to a household qualifying at the 80% income level.
Deep Rent Skewed Projects
In the case of deep rent skewed projects, the "140% rule" is replaced by the "170% rule." This rule does not change for owners who select either the 20/50 or 40/60 minimum set-aside. However, if an owner elects to use the Average Income Test, and a low-income household recertifies with income in excess of 170% of the greater of -
60% or area median gross income, or
the imputed income limitation designated with respect to the unit in which the increase in income has occurred,
the next low-income unit may not be occupied by any household whose income exceeds the lesser of 40% of area median gross income or the imputed income limitation designated with respect to the newly vacated unit.
Example #2 (25 unit deep rent skewed one-building project with ten low-income units)UnitDesignated Income Limit
1 60%
2 40%
3 80%
4 60%
5 80%
6 30%
7 60%
8 60%
9 50%
10 80%
Assume a 50% income limit of $35,500. The 80% limit is $49,700.
Since the project is deep rent skewed, at least 15% of the low-income residents must have incomes of no more than 40% of the AMGI. Since this project has a 40% and 30% unit, that requirement is met.
The household in Unit 10 recertifies with income of $84,500, which exceeds 170% of the 80% income limit.
The resident in Unit 6 moves out. Since this unit must be rented at the lesser of the 40% income limit or the imputed income limit for that unit, Unit 6 must be rented to a household qualifying at the 30% income limit. If the household in Unit 5 moves out, that household will have to be replaced by a household at or below the 40% income limit.
Tracking
While this new election will provide many potential benefits to a project - especially in terms of financial feasibility and a widening of the low-income market, implementation of the Average Income Test will be complex. Careful and ongoing tracking of each low-income unit will be necessary to ensure that the 60% average is maintained. Developers of LIHTC software are certain to update their products in order to assist in this tracking, but until that is done, owners are encouraged to develop in-house systems for doing so.