This article is a follow up to the one I posted on March 26, 2018, relating to the Average Income Test which was included in the “Consolidated Appropriations Act, 2018,” as a third set-aside election for Low-Income Housing Tax Credit (LIHTC) projects.
In my example of what could happen if the 60% of Area Median Gross Income (AMGI) was exceeded (see example below), I stated that units with imputed income above the 60% limit would be removed from the building’s applicable fraction.
Example
Assume a one-building project with a ten-unit building (all units the same size) with the following unit designations:
Unit Designated 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, move a household into Unit 6 that is at the 40% income level, and the average of the imputed income limitations is 61% and Average Income Test has been violated. One outcome of this violation could be that the 80% 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.
I discussed this scenario with a state agency compliance director that I hold in high regard, and she has a different perspective on how this situation would be handled. Her thought was that only the ineligible household (the 30% unit that was rented to a 40% household) would be removed from the applicable fraction, making the applicable fraction 90%. Since the project would still meet the 40% minimum, the 80% units would still be entitled to credits. I certainly agree that renting the 30% unit to a 40% household could result in a loss of that unit, which would make the applicable fraction in my scenario above 60%.
This is a reasonable position, and I would agree were it not for the language in §103(a)(C)(ii)(II) of the Act, which states “the average of the imputed income limitations designated under subclause (I) shall not exceed 60 percent of area median gross income.” The use of the word “shall” places a strict requirement on the property and indicates that if the average imputed income exceeds 60% of the AMGI, the Average Income Test is not met. This is part of a “special rule” relating to the Average Income Test and does not exist for the 20/50 or 40/60 elections.
While this language is clear and unambiguous in requiring that the 60% average income level must be maintained, the Act itself is silent concerning the result of exceeding the limit. The example I provided above relative to removing the units over the 60% income level from the applicable fraction was based primarily on my informal discussions with staff of both the House Ways and Means Committee and the Senate Finance Committee. In both cases, it was indicated that this view was a likely reflection of Congressional intent. However, the Act itself does not state that this would be the result of failing to adhere to the 60% average requirement, and in the end, my described result is only my opinion of the approach that could be taken. As noted above, it is entirely possible that if the 60% average is exceeded, the IRS could take the position that the Average Income Test was not met and that the project is not entitled to any credit. While this would be a draconian position for the Service to take, it is not inconceivable that it would do so. Especially when one considers that failure to meet either the 20/50 or 40/60 test does result in a loss of all credit.
Ultimately, unless Congress issues clarifying guidance, we will need to await information from the IRS regarding the effect of a violation of the Income Average Test.
As I recommended earlier, owners who have not yet filed IRS Form 8609 with the IRS for projects expected to begin credits in 2018 may want to wait until the IRS issues revised 8609s and clarifying guidance before submitting the 8609. However, owners should also keep in mind that if a projects Extended Use Agreement (EUA) has already been executed and recorded, the requirements of that agreement will have to be met – unless the HFA agrees to amend the agreement, which many are hesitant to do.