The proposed regulations are intended to provide clarity around the ‘income averaging’ flexibility, the third minimum set-aside for the Housing Credit. The AHTCC advocated for the income averaging flexibility in order to make more types of affordable housing financially feasible and allow the program to serve a broader range of low-income tenants. It was first introduced in legislation in the Affordable Housing Tax Credit Improvement Act of 2017 and was enacted through the 2018 omnibus spending package.
However, we are concerned that the IRS’ proposed regulations will severely limit utilization of the income averaging flexibility, and we propose mitigation remedies to ensure that income averaging remains a viable option. For more information about our concerns, see an article in Tax Notes Federal.
The deadline for comments is midnight ET tonight, December 29.
Concerns with Proposed Regulations
The AHTCC is concerned that the proposed regulations will severely limit utilization of the income averaging flexibility. The proposed regulations provide for substantially greater risk than either of the two existing set-aside tests, with drastic and punitive consequences that would likely serve as a deterrent to using the income averaging option. Under the proposed regulations for the average income set-aside, only a very small number of units leased to higher-income tenants would threaten the tax credits for the entire development, whereas with the existing two set-asides violations require a systematic failure to lease units to qualified tenants.
We also believe that the proposed regulation unduly penalizes serving tenants between 60 and 80 percent of area median income. Tenants below 80 percent of area median income are considered low-income for nearly all other affordable and assisted housing programs, and by enacting the income averaging flexibility Congress recognized the value of serving the full range of low-income tenants through the Housing Credit program. Temporarily serving a higher proportion of tenants between 60 and 80 percent of area median income until the original income mix can be restored should not cause a total failure of the development to qualify for the Housing Credit program.
Additionally, the proposed regulation would prohibit the change in designation of the units once made, which would create several compliance issues.
To address these concerns and to ensure that income averaging remains a viable option, we recommend that the IRS pursue alternative interpretations of the statute, which we believe are more closely aligned with the policies expressed in the original two set-aside tests and the risks that the investment community has accepted in making Housing Credit investments. We propose the following for consideration:
- Alternative Interpretation: If 40 percent of the units are leased as designated, any unit which is not leased or available to be leased to a tenant at such designated income and rent level would not be eligible for Housing Credits in the year it fails to satisfy that condition, and may be subject to recapture to the same extent as a non-complying unit under the two other set-aside elections. However, the minimum set-aside would be met.
- Second Alternative Interpretation: Testing is done on any 40 percent of the designated units, and so long as the average income for any 40 percent of the units is 60 percent of area median income or less, the minimum set-aside has been met. Therefore, if a development has substantially more than 40 percent of the units as designated units, it would take substantial non-compliance to fail to meet the average of 60 percent of area median income.
We also recommend allowing for changes in unit designations, as well as recommendations related to mitigation remedies. See our full comment letter here.