Aspire to Average! - Part 3

Benefits & Challenges that Income Averaging Presents

We took a few-week break on this topic while we conducted several training sessions for state and investor clients and a very well-attended webinar for a management company on the topic. We came back with several great questions from these sessions to discuss here.

On March 23, 2018, an omnibus spending bill, the Consolidated Appropriations Act of 2018, contained provisions that made significant changes to the Housing Tax Credit program. One of these provisions is a new minimum set-aside, which the law refers to as the Average Income Test. This series of articles discusses common questions about this option, what we know about it, and questions that are still unanswered.

Series Outline

Part 1. Which Projects Can Use Averaging and When?

Part 2. How Does Income Averaging Work?

Part 3. Benefits & Challenges Income Averaging Presents

Part 4. The Available Unit Rule & Conclusion

This article will cover why the Average Income Test may be a very good thing for many properties. Also discussed will be what challenges and unknowns we face when implementing the new minimum set-aside.


Why would we want to use the Income Average Test? What benefits are there?

Answer: Among others, there are three major benefits to the averaging option. One directly relates to the financial viability of the property, the second to an increased renter pool and the third to the preservation of older federally-funded properties.

Asset management benefits. 70 and 80% units will generate more income when compared to the former highest possible rent based on the 60% limit. True, these are balanced with lower set-asides to achieve an average of no more then 60%. However, most state allocating agencies have already required or incentivized lower set-aside units through their allocating process. The higher set-asides can balance these out and result in greater rent revenue.

Additionally, applying higher rents could allow for the possibility of higher debt leveraging based on higher anticipated income.

Finally, even if unit rents are maintained at the highest set-aside of 60% for the foreseeable future, selecting the Income Average Test would allow for the possibility of higher rents if unforeseen asset management issues arise.

The below graphics demonstrates how the lower set-asides can be balanced with the new higher set-asides. Using current state set-asides, the average is 53%. By adding one, two and then three 80% units, the average increases incrementally to 59% and balances out the lower set-aside units.

Benefits to residents. Essentially, the new set-aside option raises the definition of "low-income" to include up to 80% income households. This means that a property can assist more people. Additionally, HUD studies have indicated that the greater the socio-economic mix at a property, the more economic opportunities low income households have.

Preservation. Many properties funded by other programs have higher income limits than 60%. This includes public housing, Rural Development and the HOME program, all of which incorporate 80% limits. Even programs that have lower income limits, such as those funded by post-universe Section 8, often have several households whose income has increased to over the 60% limit with time. Many of these programs also prohibit termination of tenancy just because a household's income has increased. To preserve these older properties, a tax credit acquisition/rehab is one of the best options. However, in the past, any households who were over 60% limits would not support tax credits at rehab, and incentives to get these households to move voluntarily can be expensive. The Uniform Relocation Act applicable to properties with federal funding also potentially requires other costs be paid for many months for displaced households. The higher limits may allow more households to qualify for tax credits, minimizing displacements and incentive costs and possible credit loss when over-income households do not qualify and chose not to move.



Sounds great! Why would state agencies object?

Answer: Through their allocation processes, states may impose more restrictive requirements than are federally required. Many states have created incentives or requirements to lower set-asides to achieve lower average affordability. In the above graphics example, the state may have intended to limit average affordability to 53, 55, 57 or 59%. This would limit set-asides that could be raised to 80%, as demonstrated in the graphics. One of the few states agencies to speak to the new average option at the point of this writing is the California Tax Credit Allocating Committee (CTCAC) HERE. The CTCAC has limited set-asides to an average of 59% for noncompetitive (bond) credits and 50% for competitive projects. In states where average affordability is lowered intentionally, it is possible that applying higher income limits, while restricting the rent limits may satisfy the state while allowing the benefits of a deeper rental pool. As this does not disadvantage low income renters, while potentially helping more households, this approach is likely to appeal to states and to meet their missions to provide housing, while also minimizing the need to re-underwrite.

Finally, we should realize the practical matter that, for projects already in the pipeline but with unelected minimum set-asides, there is significant work revising paperwork, underwriting and regulatory agreements. There is a cost to this, and states may not be willing to undertake this for owners who have already committed to the old set-asides.


What if we want to elect the averaging set-aside? What issues do we have to work through?

Answer: There are three primary interested parties, each with specific areas of concern that will need to be addressed. These include management, investors and the state. Action plans will need to be developed to address their concerns. The below indicates an order of approach for these parties, but variations will occur. Investors, for instance, will likely want to know if a state HFA concurs with the choice before amending partnership agreements. Also, the below will be useful for owners seeking an adjustment to past-allocated credits where the MSA has not been elected. Future QAPs, however, will formally spell out the state policy for the new set-aside. We assume that following the requirements of the QAP will address state concerns. Because of the complexity of the new rule, however, states are still likely to request the management plan recommended below for owners seeking the new election.

1. Management. Vital note: this will not be a good option for every owner and/or agent. A diligent general partner (or managing member of an LLC), will need to be comfortable that the management agent they use is highly competent to handle the new option. It is important that a GP not let the promise of higher rents blind them to the serious and very real risk of violating the minimum set-aside and jeopardizing all credits at a project through mismanagement.

Action Items |Owner/Agent Plan

  • Document SPECIFIC plans for managing the set-aside. At a minimum, concrete plans for how the following matters will be handled should be present before a general partner is comfortable implementing the new average set-aside.

  • How set-asides will be managed, and compliance ensured against human error.

  • Establish if the management software used by the agent capable of handling the new set-aside.

  • Identify the person(s) who will specifically be responsible for establishing and monitoring compliance. These should be exceptionally qualified for cutting-edge compliance work, with unusual depth of understanding. Many Compliance Directors, who are very good at following existing rules will not be well suited or comfortable complying with and managing risk for a provision that has elements that are not completely defined yet.

  • Determine how, for less than 100% tax credit properties, uncertainty with respect to the Available Unit Rule will be handled (see next article).

  • For properties already in the pipeline, but that have not elected their minimum set-aside, determine if higher rents will be sought along with the higher set-asides. If so, determine if the state is willing to re-underwrite and what they will need to accomplish this.

2. Investors. A General Partner will need to ensure that the investors are amenable to choosing the new set-aside. Technically, the minimum set-aside is generally a general partner option, and investors need to maintain an arms-length relationship with daily management decisions to limit their liability. However, eliciting investor opinion is crucial in maintaining a good relationship with them. Partnership agreements may also have imposed a minimum set-aside option that a GP cannot simply opt out of by unilateral choice. Investors will likely want assurances that the general partner and agents have the above-discussed plan to handle the new compliance details and minimize risk of unknown factors presented by the new option.

Action Items | Addressing Investors

  • Discuss the management plan with investors to establish a comfort level with them.

  • Investor will need to amend partnership agreements, as necessary.

3. State allocating agency. As listed above, state agencies are likely to have concerns while considering the option of an owner electing the Income Average Test. Owners must address these and also demonstrate competence to apply a new compliance rule.

Action Items | Addressing the State HFA

  • Discuss the matter with the HFA to establish a comfort level with them, including the management plan to handle the set-aside and that the investors have bought-in.

  • The QAP may need to be amended for past allocations, although most states that have addressed this matter have determined that QAP adjustment is not required.

  • Allocating documentation may need to be revised.

  • The LURAs, if registered, will need to be amended to reflect the new set-aside.​

  • An adjusted 8609 needed to be released by the IRS. Part 1 will need to be executed by the state and then submitted to the owner before the set-aside can be elected. Update: the revised 8609 was released on May 31, 2018. Our Blog announcement, with links to the IRS form, can be found HERE.


What challenges remain and are there questions still unanswered?

Answer: Yes, there are still questions that we will look to the IRS to answer. We list a few of these below with some of our thoughts.

  1. Are the set-asides fixed at lease-up, and then not changeable? Our thoughts: probably not. The law simply requires an average of set-asides. Flexibility in adjusting set-asides to address compliance issues while always demonstrating that an average is maintained would seem to be in keeping with the current operation of the program and the new statute. It is also noted that the older minimum set-aside options allowed for flexibility of which units are specifically tax credit, as long as a 40% minimum is maintained. We see no indication that that has changed with the adjusted rule. It is possible, however, that set-asides, if specifically designated in the LURA, may be the only options available.

  2. If I lose a unit to noncompliance, and this also moves my average over 60%, will I lose other units as tax credit until my 60% average is restored? Our thoughts: almost surely. The minimum set-aside has always defined the low-income limit for a project and determined which units can be used for the minimum set-aside for the project and the applicable fraction for each building in a project. This was always 50 or 60%, depending on the set-aside. The difference is that the average of 60% now determines which units can be included for the new set-aside. Units that cannot be counted any longer because of noncompliance are lost as tax credit units, but units set aside at lower than 60% lost to noncompliance may also throw the average over 60%. Conceivably, the owner will then need to demonstrate a 60% average by selecting additional, higher set-aside units to exclude from the minimum set-aside and applicable fraction. An owner may choose to re-designate units that are occupied by households that now qualify at higher set-asides to those set-asides to fix the average. These units are still protected by tax credit leases, so no greater rents will probably be realized when these units are lost or re-designated at higher set-asides. Again, the set-aside options available may be limited to set-asides established in the LURA. Presumably, as long as their actual rent and income limit compliance is maintained, these units will be good for credits once compliance is restored in the triggering non-compliant units.

  3. Will LURAs indicate designated set-asides? How about specific units or bedrooms sizes? Our thoughts: we do not know, and states may vary on this matter. We feel that it is likely that states will specify specific percentages of units that must be maintained at specific set-asides, as well as unit sizes, to ensure an even distribution of set-aside units. As the federal minimum set-aside does not involve unit sizes, if a state does specify a mix of unit sizes, compliance with these will likely be treated as a state compliance matter rather than an issue with the federal set-aside, as long as a 60% average is maintained among all tax credit units.

  4. Is the Income Average Test likely to be usable at 40-60 properties going through resyndication? Our thoughts: this will probably be a problem. The old set-asides under an original extended use agreement continue to exist when the commitments of a new agreement are added. Over-60% units will not qualify for tax credits under the original agreement and will likely violate the applicable fractions for buildings when examining compliance with the original agreement. Until such time as the IRS clarifies a path forward where doing so is acceptable, owners should not elect the new set-aside option at resyndicated acquisition/rehab projects.

  5. How does the Available Unit Rule work? The new rule addresses how the AUR works, but it does not answer all questions, especially for projects that are less than 100% tax credit. Stay tuned for our final article!

Next article: The Available Unit Rule & Conclusion

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