The IRS issued proposed regulations that provides guidance on the average income test, the next available unit rule, and mitigation actions for purposes of the low-income housing credit. If the taxpayer fails to meet certain requirements to qualify as a low-income housing project, they would need to recapture part of the low-income housing credit. The guidance is effective once published as final; however, taxpayers may rely on them for tax years beginning after October 30, 2020.

Set-aside tests and the average income test. The amount of the low-income housing credit for any tax year is an amount equal to the applicable percentage of the qualified basis in each qualified low-income building. A taxpayer claiming the low-income housing credit must elect and satisfy one of three set-aside tests:

-the “20-50” test;

-the “40-60” test; and

-the “average income” test.

The average income test is satisfied if at least 40 percent of a building’s residential units are both rent-restricted and occupied by tenants whose income does not exceed the imputed income limitation designated by the taxpayer for the unit. The imputed income limitation for any unit must be 20, 30, 40, 50, 60, 70 or 80 percent of area median gross income (AMGI). However, the average of the designated imputed income limitations may not exceed 60 percent of AMGI.

Next available unit rule. The guidance updates the next available unit rule for the average income test. A unit generally continues to meet the average income test if the tenant’s income later rises above the designated AMGI limit. In situations where multiple units are over-income at the same time in an average income project that has a mix of low-income and market-rate units, the guidance provides that a taxpayer does not need to comply with the next available unit rule in a specific order. Instead, 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.

Mitigation actions. In some situations, the average income requirement may cause adverse consequences in a unit’s ability to maintain status as a low-income unit. In the absence of some relief provision under the average income test, the entire project would fail, and the taxpayer would experience a recapture of the low-income housing credit. If the taxpayer takes a mitigating action within 60 days of the close of a year for which the average income test might be violated, the taxpayer avoids total disqualification of the project and significantly reduces the amount of recapture. Two types of mitigating actions have been added: conversion of a market-rate unit and removing low-income units. The guidance provides more detailed rules for describing the mitigating action and the tax treatment of removed units.

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Please call our office, we can assist you with the calculation of the “average income” test for the low-income housing credit, review the mitigation actions, and determine how the rules may apply to your business.