The Consolidated Appropriations Act of 2018, which was signed into law on March 23, 2018, included two provisions affecting the low-income housing tax credit (“LIHTC”) program. One provision temporarily increased the total dollar amount of LIHTC that can be allocated. The other provision added a new minimum set-aside (the “Income Averaging Set-Aside”) that, for the first time, permits units occupied by tenants with incomes greater than 60% of area median income (“AMI”) to qualify as LIHTC units. Although the potential benefits of the new minimum set-aside are substantial, there are, at least as an interim matter, several issues that LIHTC agencies, investors and lenders should consider in determining whether to permit the Income Averaging Set-Aside to be elected.
The intended benefits of the new Income Averaging Set-Aside are both qualitative and quantitative. On the qualitative side, the Income Averaging Set-Aside is intended to make LIHTC properties available to a broader range of families, meet Fair Housing goals by increasing economic diversity at tax credit properties and preserve existing affordable housing stock by allowing more (over-income) tenants at existing projects to qualify as low-income tenants when a project is re-syndicated. On the quantitative side, the Income Averaging Set-Aside is intended to help mitigate reductions in LIHTC pricing (and LIHTC equity) as a result of last year’s reduction in the corporate income tax rate by increasing the amount of debt that a project can support.
Under the Income Averaging Set-Aside, a project qualifies for LIHTC as long as at least 40% of the units in the project are tax credit units with an average income level of 60% of AMI and rents equal to 30% of the qualifying income level. Designations of the units to be taken into consideration in determining whether or not the set-aside is met must be made on a unit-by-unit basis, with income designations made in 10% increments ranging from 20% to 80% of AMI.
The Income Averaging Set-Aside election is made when the 8609 form is filed. This means that, at least as a matter of federal law, the Income Averaging Set-Aside can be elected for any building that has not yet filed its 8609. Because there is no federal requirement to distribute unit-by-unit income designations evenly based on unit sizes, designating larger units as having higher income limits could allow a project to generate significantly higher income, which would support more debt and offset reductions in LIHTC equity as a result of last year’s reduction in the corporate income tax rate.
Tax Credit agencies, however, do not appear to be required to allow income averaging. Further, for projects where the initial equity and construction financing closing has already occurred, partnership agreements and construction financing documents likely require the owner to elect the 40/60 minimum set-aside. In this circumstance, owners likely will be required to obtain the consent of both the investor and the construction lender to elect the Income Averaging Set-Aside. Moreover, where an extended use agreement has already been executed and recorded with respect to a project, that agreement would have to be amended.
For several reasons, Tax Credit agencies, investors and lenders may have legitimate concerns as to whether or not they should permit a project to elect the Income Averaging Set-Aside. In part, this is because the underwriting of projects that are already in the pipeline would not have contemplated income averaging and the market studies probably did not address whether there is a market for tenants with incomes either below or above 60% of AMI. Just as importantly, there are several unanswered questions as to how the Income Averaging Set-Aside election will be implemented. The most significant of these questions are: how will the next available unit rule be applied and what are the consequences of failing the Income Averaging Set-Aside test? Depending on how these questions are answered, it is possible that the consequence of one unit being leased to a non-qualified tenant could be the failure to satisfy the Income Averaging Set-Aside, resulting in the loss of all LIHTC until the non-compliance is corrected.
At least until guidance is received on how the next available unit rule will be applied and what the consequences of a failure to satisfy the Income Averaging Set-Aside will be, investors and construction lenders should carefully consider the risks in determining whether or not to consent to an Income Averaging Set-Aside election.
Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.
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