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Low Income Housing Tax Credits & Pitfalls of Income Averaging

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The Consolidated Appropriations Act of 2018 created a new minimum set aside election for new Low Income Housing Tax Credit (LIHTC) projects.

Income averaging is one of the set-aside elections intended to determine whether a project qualifies as a low-income housing project and would receive LIHTC.

It allows LIHTC owners to elect to serve households with incomes of up to 80% of area median income (AMI) and have them qualify as LIHTC units, so long as the average income/rent limit in the project remains at 60% or less of AMI.

Owners who elect income averaging must also commit that at least 40% of the units in the project have an average income level of no more than 60% of AMI, and the rents for these units must be equal to 30% of the qualifying income level.

Income averaging is a highly complex test with many variables. Below are a few frequently asked questions to help you better understand the concept and potential pitfalls associated with income averaging.

What are the basic steps to obtain Low Income Housing Tax Credits, and where does income averaging come into play? The basic steps to obtain LIHTC are as follows:

  1. Find your investor
  2. Apply for LIHTC
  3. Receive your reservation of credits
  4. Receive your binding commitment of credits from the State Housing Finance Agency
  5. Place your building in service
  6. Work with Maner Costerisan to have your cost certification completed
  7. Complete your Form 8609 (inclusive of minimum set-aside requirement testing and income averaging)

What is a minimum set-aside? A minimum set-aside is a test used to determine if a building is a qualified low-income housing project. The taxpayer chooses the test and must be satisfied during the duration of the project and the compliance period.

What kinds of tests fulfill the minimum set-aside requirement? There are three tests allowed to fulfill the minimum set-side test requirement, all with varying applicability.

  1. 20-50 test
    • 20% of the units are set aside for households with 50% of area median income.
  2. 40-60 test
    • 40% of the units are set aside for households with 60% of area median income.
    • Allows a greater population of potential renters (60% income limit) and higher income/revenue to entity (using 60% income limits)
  3. Income averaging test
    • At least 40% of units are to be BOTH:
      1. Rent-restricted, AND
      2. Occupied by individuals whose income don’t exceed imputed income limits by the taxpayer
    • The average CANNOT exceed 60% area median income (AMI)

What happens if an organization doesn’t fulfill the testing requirement? Failure to meet these minimum set-aside requirements can cause loss of credits (current or future) or credit recapture, during your credit period or compliance period.

The Pitfalls of Income Averaging

Income averaging is the newest of the minimum set-aside requirement testing options – with new proposed regulations coming out as recent as 2020.

While there are some upsides to income averaging, the consensus is that the pitfalls out-weigh the good (at least under current proposed regulations).

Pros of Income Averaging

Unit Diversification: Income averaging allows for incomes to be up to 80% of AMI, if the development-wide average is 60% or less. This allows for a broader mix of incomes and makes developing LIHTC properties attractive in places where it is now difficult.

Less Evictions: Income averaging can also be beneficial for rehabs and reacquisitions. If a project has households that are above the 60% AMI threshold, blending the unit rent mix will avoid the eviction of tenants that may have been over-income under a different set aside election.

More Rural Opportunity: Income averaging is most beneficial if projects can capture 80% AMI rent. This can be especially helpful for projects in rural areas that have a lot of units below 40% – income averaging allows opening some 70% and 80% units.

Unit Designation Flexibility: An important distinction is the 60% average area medium income is not based on individual’s income level, it is based upon the developers designated unit income limits and compliance based upon those designations. For example, a family with income at 68% AMI could move into a unit designated as a 70% or 80% unit since there income is less than the designated threshold. However, the number that is utilized in the average income test is the designation of the unit (70 or 80%) not the family income (68%).

Special Considerations for Increased AMI: Special rules apply when a household’s income increases above 140% of the current applicable income limitation (i.e. 140% above either 50% or 60% AMI). If the occupants’ income increases to more than 140% of the applicable income limitation the unit may continue to be counted as a low-income unit as long as two things happen:

  1. The unit continues to be rent-restricted AND
  2. The next available unit of comparable or smaller size in the same building is occupied by a qualified low-income household.

The guidance issued has indicated that if there are multiple over-income units that the next available units don’t have to be leased in any certain order.

Pitfalls of Income Averaging

No Designation Leeway: Income averaging offers no leeway on designation. You cannot change the percentage of each unit, which means that reasonable change requests might not be able to be met or you might lose credits. A relevant example – All units on the top floor of a building area designated as the 80% AMI units. If residents become unable to walk upstairs, they cannot be moved to a lower floor unit, if their income is too high.

Permanent Elections and Designations: Another important consideration is that the election is made in year 1 and is irrevocable. Over time, the population in the geographic area might change and that unit mix allocation may no longer be beneficial or practical.

Another pitfall with income averaging is if a household transfers to a different unit, you can’t swap the designations. The designation stays with the unit, not the household.

Compliance Challenges and Limitations: The largest pitfall of all is what happens in the event of non-compliance: the property could jeopardize the tax credits for any buildings in noncompliance. If buildings exceed the 60% AMI average, they fail the minimum set-aside test and will be considered in non-compliance.

The proposed regulations provided some relief and mitigating actions that can be taken to cure non-compliance by providing a 60-day window from the end of the year of non-compliance to resolve the issue. This window is very short. Compliance issues are often brought up well after year-end – and at that point it’s too late to find a remedy.

Designating buffer units is one option to help resolve this issue. If this strategy is utilized, it’s important to review the cost benefit of utilizing a buffer unit. In many instances, the cost out-weighs the benefit of the average income when the proposed regulations are applied. Typically, the situation that allows for this to be effective is when the building has vacant market rate units or those units already occupied by a tenant that is low-income eligible.

What’s Next?

If you have already elected income averaging and are placed in service and operating currently:

  • Perform the due-diligence in first year, before close of first year, to assess feasibility. You have until close of first year to change any designations.

If you’re looking at new project:

  • Stop and ask yourself why you’re selecting income averaging. As the proposed regulations are written, you’ll need a large number units at 58% or lower, instead of 60% AMI.
  • Ask yourself, “Would the project work at 40-60 instead?” This is usually a solid selection.

In either situation, we would recommend consulting with your Maner Costerisan team and your tax credit equity syndicator.

Interested in learning more? Could you use some expert assistance in determining which test may be best for your project or digging into income averaging in more detail?

Maner Costerisan’s team of specialized affordable housing experts have the industry know-how, strong relationships with state and local policymakers and a proven track record of helping developers, investors, management companies and syndicators find immediate and long-term success with their investments.

We know tax law front to back and are two steps ahead of the latest legislative changes, so you can capitalize on every tax opportunity available.

Dave Henson, Business Development Manager - Maner Costerisan

Dave Henson

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