Real World Use of Average Income Test Option Sheds Light on its Applicability

Published by H. Blair Kincer on Wednesday, June 5, 2019 - 12:00am

Last year Congress enacted a new tool to extend the reach of the low-income housing tax credit (LIHTC) to meet the country’s varied affordable rental housing needs: the average income test. Since its enactment, the option has generated a lot of discussion and raised many questions about its implementation. Now, as developers and states have started using the average income test option, its applicability can be better assessed.


The Consolidated Appropriations Act of 2018 provided a new set-aside option for designating homes in LIHTC properties called the average income test. The provision was initially introduced as part of the Affordable Housing Credit Improvement Act (AHCIA) by Sens. Maria Cantwell, D-Wash., and Orrin Hatch, R-Utah, in 2016 and again in 2017 with a House companion bill led by former Rep. Pat Tiberi, R-Ohio and Rep. Richard Neal, D-Mass.

The average income test was one of the more popular provisions of the AHCIA and stands to benefit developers and residents alike.  Prior to this option, LIHTC developers had two minimum set-aside requirement options: the 20-50 set-aside for households with incomes at or below 50 percent of the area median income (AMI); and the 40-60 set-aside for households at or below 60 percent AMI.  The average income test provision allows a wider range of households to benefit from the LIHTC. Developers are now able to provide housing for households at the lowest income levels without the need for additional subsidy.

The new set-aide option can benefit a range of community types, from high-income areas to communities with very low median incomes as is typical in rural areas to jurisdictions trying to support mixed-income development. In high-income locales, prior to the average income option, households with incomes over 60 percent of AMI earned too much to reside in LIHTC housing (they were priced out of the 20-50 and 40-60 set-aside options), but in most cases did not earn enough to afford market rate housing. At the other end of the income spectrum, the average income provision makes the development of homes affordable to households earning less than 40 percent of AMI more financially feasible because the average income option allows the rents of homes set aside for higher-income households to offset the lower rents of the homes set aside for lower-income households.

Real-World Applications

For developers considering using the average income option, market analysis can provide key insights the market’s affordable housing needs and the appropriate unit designation in LIHTC developments in which the average income test will be employed. Market analysis has been modified to account for the introduction of this third set-aside option.  Novogradac has completed many market studies and appraisal on properties employing the average income test. Generally speaking, the primary modification is to analyze the marketability of the homes at 80 percent of AMI. This entails a deeper dive into the income levels of the current market-rate tenancies. Analysts determine if households earning 80 percent or less of the AMI are living in market rate homes and try to assess the depth of demand. Further, they evaluate and analyze the achievability of rents affordable to households at or below 80 percent AMI versus market-rate, as well as any rent advantage.

Geographic Considerations

The benefits to developers and households in high-income areas is more obvious but other market places can take advantage of the average income test. In theory, the average income test provides developers with a larger pool of potential renters in locations where market-rate rents are slightly above, if not equal to or less than, the maximum allowable rents for households at or below 60 percent of AMI.  The benefit in these cases is not found in being able to charge higher rents but rather having a larger income-eligible tenant pool from which to draw.  One would expect this to play out in rural areas and other communities with low median incomes, but, at least in the case of the former, Novogradac’s limited real-life practice has yet to bear this out.  While there are a number of rural LIHTC developments that have employed the average income test option,  most of the market study assignments completed by Novogradac that involve the average income test to date have been in suburban and urban areas. The original intention was that developers in rural areas would be greatly assisted by having a mechanism that would increase the demand pool. But the average income test is still a relatively new tool and adoption has been somewhat slow. As use of the average income test option continues to become more widespread, additional incentives, such as a rural basis boost, may be necessary to further encourage development in rural areas. In any case, extended observation of the average income test will be needed to determine its applicability outside of high-income communities.

Designation Questions

Numerous questions exist around designating income limits for particular homes – is this a formal process; must the designations be approved or submitted to anyone; how and when can the designation occur; are there circumstances in which mixed-income developments  market-rate homes could become LIHTC units? One major point of interest is whether the unit designations – how many homes are set-aside for households at the various income levels – can be changed throughout the life of a LIHTC property. Novogradac believes that once the designations are recorded in a regulatory agreement, they will be difficult to change. As such, formalizing the designations in the regulatory agreement is discouraged.  Another aspect to consider is whether states will require developers to spread income limitations across the unit mix within a property – i.e. if a LIHTC property is to have one-, two- and three-bedroom units, and income limitations of 20 percent, 50 percent, 70 percent and 80 percent of AMI, then must each bedroom type be represented at each income level?  

Differences among States

At the time of this writing, each state will have to determine how the average income test is implemented.  The Internal Revenue Service (IRS) has not weighed in with guidance, and may not do so, beyond what was provided in the federal law. This would leave it to the state housing finance agencies (HFAs) to determine how the average income test is implemented in their jurisdictions. So far, Novogradac’s review of select qualified action plans (QAPs) shows great variability: some states only allow the average income test for 9 percent developments; others for just 4 percent developments. Some states do not allow market rate homes in an average income property; others do not allow the average income test at all. Some states have issued QAPs with no mention of the new set-aside, leaving readers to wonder where the state falls on the issue. Some states require that the average imputed income limitation designated be reached in each building while others allow it to be met across the entire (multi-building) property. As time passes and more HFAs include average income test language in their QAPs, the various interpretations will be analyzed and best practices can begin to be established. Until there is more information and examples available, LIHTC property owners will want as much flexibility as possible.   

Examining provisions of two state QAPs can provide a small amount of insight. Maryland is one state that includes the average income test in its QAP and is moving forward, though representatives at Department of Housing and Community Development (DHCD) have stated they are hoping for additional guidance from the IRS. Here, the average income test is permitted for both 9 percent and 4 percent developments. Maryland’s 2018 QAP states, in addition to the average income test requirements detailed above, that the set-aside election must be made no later than the date of the execution of the development’s IRS form 8609 and the election is irrevocable. DHCD will award points based on the weighted average of area median gross income targeting by bedroom in a development.

By comparison, Virginia’s 2019 QAP includes the average income test, and states that there must be a reasonable distribution of set-asides across all unit sizes. The Virginia Housing Development Authority (VHDA) requires that all homes be low-income so no market rate homes are permitted in LIHTC properties electing to use the average income test. The initial unit mix showing the average set-aside must be provided and assigned set-aside homes must “float.”   


To continue to serve the wide variety of households and communities in need of affordable housing, the LIHTC program must be adaptable and allowed to evolve over time. The average income test provides greater flexibility and is a welcomed improvement, especially once fully implemented by states. However, more will have to be done to address the current affordable housing crisis, made worse by certain tax reform provisions. Other key AHCIA provisions, such as establishing a permanent minimum 4 percent credit, increasing LIHTC allocations by 50 percent, and providing a 50 percent basis boost for developments serving extremely low-income households, should also be enacted to complement the income average test to help address the nation’s affordable housing needs.