IRS Proposes LIHTC Average Income Test Regulations

On October 30, 2020 the IRS published a proposed rule for the low-income housing tax credit (LIHTC) average income (AI) test regulations. The proposed rule provides that if a project has multiple over-income units, it would not need to meet the next-available-unit rule in any particular order. This proposed rule also provides some flexibility in initially designating units, which needs to occur by the end of the first taxable year, the LIHTC period. The IRS is proposing limits on any subsequent changes and a process to address when units go offline for any reason. Comments on this proposed rule are due by December 29. You may read the full Federal Register proposed rule here:


  • Residential rental projects may be eligible for LIHTCs if the project satisfies a minimum “set-aside” requirement. Under the minimum set-aside requirement, a portion of the residential units in the project must remain rent-restricted and occupied by tenants whose income is equal to or less than a specified percentage of area median gross income. Prior to 2018, there were two alternative ways to satisfy the minimum set-aside requirement: the “20-50” and “40-60” tests.
  • In 2018, Congress provided a third way to satisfy the minimum set-aside requirement, which is the average income test. The average income test requires that 40% or more (25% in New York City) of the residential units in the project must be rent-restricted and occupied by tenants meeting an “imputed income limitation” designated by the project owner. To satisfy the average income test, the taxpayer must designate an income limitation for each low-income unit—between 20% and 80% of area median income, in 10% increments—and the average of such limitations must not exceed 60% of area median income.
  • The proposed rule requires that all low-income units in a property average 60% of area median income or less in order to meet the minimum set-aside requirement. If a unit goes out of compliance for any reason, the proposed rule would provide the taxpayer up to 60 days after the end of the year in which the average was violated to take a mitigating action to prevent the project from violating the minimum set-aside and being disqualified from receiving credits for that year (or ever, if the violation occurs in year one). The rule provides two forms of mitigating actions and prohibits the taxpayer from changing the designated imputed income limitation of units in order to reestablish compliance with the minimum set-aside.

Guidance Under the Newly Released Proposed Regulations

The proposed regulations offer guidance on the initial satisfaction of the average income test and also provide direction on certain aspects of the project’s ongoing compliance with that same test.

Designation of Units

Under the proposed regulations, the state credit agencies that administer the LIHTC program will be tasked with establishing a process for the designation of income limitations. These proposed regulations will, however, require the taxpayer to make the designations by the end of the first taxable year of the LIHTC period.

Mitigation in the Event of Noncompliance

When a project uses the average income test, there is a higher risk of failing the minimum set-aside requirements in a given year. This is because even if all of the units in the project are initially set aside for qualifying tenants, a single unit falling out of compliance could, under certain circumstances, cause the average income limitation of the designated units to exceed 60% of area median income, thereby causing the project as a whole to fail the average income test and, as a result, the minimum set-aside requirement. Failure of the minimum set-aside requirement would cause the entire project to be ineligible for LIHTCs.

  • Recognizing this risk, the proposed regulations allow for certain “mitigating actions” to correct and address the noncompliant units. In all cases, these mitigating actions must take place within 60 days of the end of the year of noncompliance. Therefore, any noncompliance that is discovered after this deadline cannot be cured.
  • The first mitigating action involves converting market-rate units into low-income units. This mitigating action may avoid a total loss of the LIHTC, but it requires the project to have eligible market-rate units available for conversion.
  • The second mitigating action involves removing other compliant low-income units from the project’s applicable fraction, which could reduce the overall amount of LIHTCs that the project is eligible to claim.
  • There is also a potential third type of mitigation which involves re-designating the income limitation of low-income units. The proposed regulation is requesting comments on this potential third type.

Application of the Next Available Unit (NAU) Rule

Normally, an increase in income of a tenant who was compliant initially will generally not disqualify a unit for the purposes of the average income test, so long as the next available unit in the project is leased to a tenant meeting either (i) the applicable income limitation for such available unit or, (ii) in the case of a market-rate unit, the limitation that would permit the project to maintain an average income limitation of no more than 60% of area median income.

The propose regulations provide that the taxpayer does not need to comply with this NAU rule in any specific order. For example, a 30% unit and a 70% unit are both occupied by tenants and their income has exceeded the relevant income limitation. The next available unit may be leased to either a 30% or 70% tenant and still comply with the NAU rule.

Effective Date and Reliance

Once the final regulations are published, these rules and mitigations would apply for taxable years beginning after such date of publication. The NAU rules would apply to occupancies beginning at least 60 days after such date, but taxpayers generally may rely on the proposed regulations until then.

As a reminder, this is not a final rule. AAFCPAs advises clients to understand the potential implications of this proposed rule, but it may be premature to take action. Please contact your AAFCPAs Partner to discuss the implications particular to your project.

AAFCPAs will continue to monitor the progress of these proposed regulations and will provide additional updates and guidance as new information becomes available.

If you have questions, please contact Sorie Kaba, CPA, at, 774.512.4071; or your AAFCPAs Partner.

About the Author

Sorie has been serving AAF clients since 1999. He has extensive experience with audits of nonprofit organizations and audits in accordance with Uniform Guidance/Single Audit and Government Auditing Standards. Sorie is highly-sought after for his expertise in serving a variety of industries including Federally Qualified Health Centers, community development corporations and their development projects with the U.S. Department of Housing and Urban Development (HUD), MassHousing (MHFA) and Low Income Housing Tax Credit (LIHTC) requirements, Community Development Financial Institutions (CDFI) entities and human services organizations. He also has extensive experience providing audit and tax services to several tax credit syndicated limited partnerships and limited liability companies.