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Final Average Income Guidance

Published by Mark Shelburne , Stephanie Naquin , and Thomas Stagg on Friday, October 7, 2022 - 12:00AM

On Oct. 7, 2022, the Internal Revenue Service (IRS) released final and temporary regulations for the average income test (AIT). The new rules contain vitally necessary improvements to the administration of the newest low-income housing tax credit (LIHTC) minimum set-aside.


The AIT has been on an eventful journey. An idea first conceived more than a decade ago, Congress enacted it with little warning in March 2018. Many developers and almost all LIHTC allocating agencies immediately saw the benefits and began implementation. Thousands of units across the country were soon part of AIT properties.

In October 2020, proposed guidance was published in the form of Treasury Regulation §1.42-19 that created significant challenges in the practical implementation of AIT that, as a result, many LIHTC equity providers started walking away from AIT properties.

However, it was just a proposal, meant to solicit feedback. In what was not a surprise, there was a lot of industry feedback. The input came during a five-hour public hearing in March 2021 and many comment letters were submitted.

On Oct. 7, 2022, the journey’s end came into sight when the final AIT guidance was released. As the guidance is being reviewed, there are a few items that stand out as important resolutions to the challenges in the proposed guidance.

Meeting the Minimum Set-Aside

The proposed regulations created an unusually dire consequence for when a unit was determined to be out of compliance in that, if without that unit’s designation the average of the remaining units in the project exceeded 60%, the project would be determined to have failed the minimum set-aside.  This concept was the dreaded “cliff effect” that has been dispelled with the final regulations. Now, the taxpayer satisfies the average income minimum set-aside test if at least 40% of the project’s residential units are eligible low-income units and have been designated in a manner that collectively averages 60% (or less). 

The reasoned response to public comment further clarifies the position:

“By removing the proposed requirement applicable to all low-income units and thus allowing a project to satisfy the average income test if it contains a qualified group of units meeting the minimum requirements, the final regulations generally avoid the outsized impact that one unit’s loss of low-income status could have under the proposed regulations.”

Further, the mitigating action described in the proposed regulations was deleted. The only reason for a taxpayer to have needed to take such action was to reduce the risk created by the proposed regulations where one unit losing its low-income status causes the project to fail the minimum set-aside. However, the regulations still have some ways to mitigate loss of credits.

Change in Unit Designation

The proposed regulations required the taxpayer to designate units from 20% to 80% (in 10% increments) by the end of the first year of the compliance period. Those designations were fixed throughout the term of the extended use period. Meaning, once a unit was designated, there was no avenue through which a unit’s definition could be changed. The rigidity of the Guidance caused the taxpayer to choose between following the average income guidance or possibly violating other federal housing program laws; not to mention the inconsistency with existing LIHTC guidance.

The final regulations allow for significant flexibility by including several circumstances in which a taxpayer could change a unit’s designation including conflicts with other federal laws, tenant transfers and as allowed for under public guidance issued by the State Housing Finance Agency (the Agency).  It is important to note that, to change a designation, it must be understood when the unit’s designation takes effect and the process through which the designation could be changed.  For projects that have elected AIT and units are occupied as of Dec. 31, 2022, the initial unit’s designation is determined on Jan. 1, 2023.  For vacant units, the unit must be designated before move-in of a low-income tenant.  In some cases, owners may wish to change the designation of occupied units to help mitigate credit loss or recapture, which also appears to be allowed by the guidance. These designations are reported to the Agency annually. If a unit’s designation is changed, the taxpayer effects a change by recording the new designation in its books and records, communicating the new designation to the Agency and retaining records of the prior and new designation retained for a period not shorter than the record retention requirement under §1.42-5(b)(2).

Effect of Unit Noncompliance

While the final regulated remove the “cliff effect” as it related to minimum set-aside, it makes it clear that for any unit to be considered low-income, it must be part of a project whose total unit designations do not average more than 60% (i.e. the project average). 

As noted in the reasoned response to public comment:

“This interpretation means that to qualify as a low-income unit in a project electing the average income test, a residential unit, in addition to meeting the other requirements to be a low-income unit under section 42(i)(3), must be part of a group of units such that the average of the imputed income limitations of the units in the group does not exceed 60 percent of AMGI.”

A definition of low-income unit specific to AIT was added to the final regulation to better help frame the expectation. If you have a unit determined to be out of compliance and, when removing that unit’s designation from the overall project average the average of the remaining units in the project exceeded 60%, then the taxpayer could only include in their annual credit calculation those units that met the definition of low-income. Meaning, the taxpayer may not be able to include all units occupied by LIHTC eligible households in their applicable fraction because they would need to remove one of those units from the average as they do not meet the definition of low-income. In other words, one unit may result in losing credits on more than one unit if you have to remove an otherwise qualified unit from the applicable fraction so that the designations of the remaining qualified units can average 60% of less.


These topics only address those major concerns that the proposed regulation created. However, the final regulation introduced more robust regulations to address how taxpayer evidence that they have met the minimum set-aside, the annual credit calculation of a building, justification for unit designation changes, processes for designating units and temporary regulations relating to reporting requirements.  We will have additional blog posts on these topics as these final and temporary regulation are fully analyzed.

Community development professionals will also have additional opportunities to learn more in the coming weeks with the Oct. 20 Examining the Updated Average Income Test Regulations Webinar as well as the Oct. 11 episode of the Tax Credit Tuesday podcast.

The guidance will be a topic of conversation at the Novogradac 2022 Tax Credit Housing Finance Conference Dec. 1-2 at the Four Seasons Hotel in Las Vegas.

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