The Available Unit Rule & Conclusion
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.
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
As mentioned in the last article, the new minimum set-aside options also modify the Available Unit Rule (AUR) in ways that leaves questions. Here that issue will be explored along with some final thoughts on how noncompliance can be corrected if necessary.
What is “over-income” for the Available Unit Rule for income averaged test properties?
Answer: The Available Unit Rule (AUR) works differently for averaged MSA properties than it does for other properties. The first difference is the threshold at which the units are considered “over-income.” For the original minimum set-asides, the threshold is reached when a household at recertification exceeds 140% of the current minimum set-aside income limit. Thus, it is 140% of the 50% limit for 20-50 properties, or 140% of the 60% limit for 40-60 properties. For the new income average test properties, the over-income test will be at 140% of the HIGHER of the 60% limit OR the designated set-aside for a unit. Practically, this means that the limit is 140% of the 60% limit, except for 70% and 80% units, which will use 140% of the 70 or 80% limits applicable to the unit.
What happens when a household exceeds 140% at income recertification for an income average test property?
Answer: As is true for all tax credit properties, the AUR imposes requirements to rent units as they become vacant to tax credit households when households who had become over-income at recertification exist in the same building. The second adjustment to the AUR for income averaged properties is the care that must be taken to re-rent the next available unit at the correct set-aside to satisfy the rule. The correct action to take will depend on whether the vacant unit is already tax credit or not.
If the next available unit is a tax credit unit, what action must be taken to satisfy the AUR?
Answer: If a unit becomes vacant and is tax credit while an over-income household is living in a comparable or smaller unit in the building, the available vacant unit must be rented to a household at the set aside at which the unit is designated. In other words, the unit will continue to be rented to the same set-aside as it was previously designated.
Income recertification is not federally required at 100% tax credit properties. Any recertifications conducted at these properties are done for state or owner policy reasons, or because another program requires income recertification. However, according to the 8823 Guide, from the IRS’ standpoint it is officially not known if a household is over-income after move-in. For these properties, the way this rule works will simply always require that units be continually rented to tax credit households at the pre-determined set-asides used to establish the income average. As is currently true, it is likely that the AUR will only be violated at 100% averaged tax credit properties if the owner moves in a non compliant household and also does not demonstrate due diligence in trying to avoid errors. For these reasons, many states that are considering allowing the Income Average Test intend to apply it to 100% tax credit properties only, where the risk of noncompliance is considerably less.
If the next available unit is a market unit, what action must be taken to satisfy the AUR?
If a unit becomes vacant and is market while an over-income household is living in a comparable or smaller unit in the building, the available vacant unit must be rented to a household at the set aside at which the over-income unit is designated. This replaces the over-income unit in the unit mix for the building and helps restore the average, not including the over-income unit(s). This must be done until the applicable fraction is restored for the building.
What if two tax credit units of differing set-asides are over-income and a market unit become available?
Answer: When it comes to multiple over-income units and the AUR, there are some matters not addressed in the statute. As the infographic below demonstrates, there are a few options. Until the IRS clarifies, as long as the vacant market unit is not rented to a market tenant, any consistent approach is likely acceptable with state buy-in. The most conservative option is generally believed to be to rent the market unit to the set-aside of the lowest over-income unit. The industry is seeking guidance from the IRS on this matter.
What if a unit is rented to a household above the designated set-aside for a tax credit unit, despite due diligence measures?
Answer: Such units will affect, not only the applicable fraction for a building, but possibly the minimum set-aside. Units that are set-aside above or at 60% will LOWER or not affect the average. Therefore 60-80% units that go out of compliance will not put the average over 60% and noncompliance will only affect the non compliant unit in the applicable fraction and in the minimum required 40% of units that must be maintained as tax credit. There is much that is unknown about what happens when lower set-aside units are lost to noncompliance. Since their loss RAISES the average, additional units may become tax credit ineligible to restore the average. It is likely that the unit will not support tax credits if any of several possible corrective solutions are not viable. To what extent these options to resolve noncompliance are allowed will depend on IRS guidance, state buy-in and the extent to which set-asides are flexible and can float among units. We sincerely believe that it is best for the industry to allow for the greatest flexibility possible to fix noncompliance within the requirement of the statute. More rigid structuring may be unnecessarily harmful to properties where mistakes happen through human error and not lack of due diligence.
Possible ways to address noncompliance in units
1. Rent vacant market units to tax credit tenants. Renting non-tax credit units (if applicable) to tax credit tenants is an obvious fix. However, formerly tax credit tenants converted to market-rate are likely to continue to qualify for tax credit rent and eviction protections.
2. Re-designate over-income units to higher set-asides. It appears possible that the only non compliant over-income situations at move-in that is not possibly fixable through re-designation of units would be when households exceed 80%. Any household that qualifies under one set-aside qualifies for all set asides above it. However, as this involves raising unit set-asides, and resident rents are likely not changeable mid-lease, lost rent revenue is likely when lower set-aside units are raised. Additionally, it has not been established if set-asides need to be established ahead of time and how flexible these can be.
3. Drop additional units until average is 60% or less. Because of how averaging works, loss of a unit could force additional units out of the minimum set-aside (and applicable fraction(s)) until the average can be re-established. To what extent the units falling out can be chosen by the owner has not been established. It is in the best interest of the property to lose as few as possible. However, units lost to noncompliance should continue to qualify for tax credit rent and eviction protections. This would have the benefit of allowing them back in the applicable fraction and minimum set-aside once compliance is restored.
Since its inception, the tax credit program has helped millions of Americans find decent, safe and sanitary housing that they can afford. The industry has long sought the Income Average Test, and with it we look forward to helping even more people. We also look forward to the asset management benefits it will provide to some properties. These will be well worth the trouble of learning to apply the new option competently.