Trump’s Omnibus Spending Plan adopts two key provisions from the proposed Affordable Housing Credit Improvement Act that will strengthen and expand low-income housing credit.
- 2018 spending plan increases housing credit ceiling by 12.5% for next four years and incorporates a new “Average Income Test” to qualify for low-income housing tax credits.
- The Average Income Test offers potential benefits to taxpayers, but questions remain as to whether States will adopt this option, the mechanics of application, and difficulties in monitoring compliance.
On March 23, President Trump signed into law the Consolidated Appropriations Act, 2018 (Spending Plan), a $1.3 trillion omnibus spending plan covering the remainder of the 2018 fiscal year. In addition to providing for increased appropriations for several affordable housing programs, the Spending Plan adopted two key provisions from the proposed Affordable Housing Credit Improvement Act (AHCIA)1 that will strengthen and expand the low-income housing credit:
- Section 42(h)(3)(I) of the Internal Revenue Code (Code) was amended to increase the housing credit ceiling by 12.5% for years 2018, 2019, 2020, and 2021; and
- Section 42(g)(1) of the Code was amended to create a permanent new minimum set-aside election known as “average income,” as further described below.
These changes are viewed as material victories for the industry, which has seen reduced equity pricing and funding gaps due to the lowered corporate tax rate under the 2017 Tax Cuts and Jobs Act (TCJA).
Credit Ceiling Increase
The credit ceiling increase under the Spending Plan represents the first expansion of the low-income housing tax credit in more than a decade.2 Pursuant to the new law, for each of years 2018-2021 the per-capita state housing credit ceiling and state credit minimum are increased by a factor of 1.125, after taking into account the cost of living adjustment. Under Rev. Proc. 2018-22, the Internal Revenue Service (IRS) announced that for calendar year 2018 this will result in an increase in each state’s credit ceiling to the greater of (i) $2.70 multiplied by the State’s population or (ii) $3,105,000. Accounting firm Novogradac & Company LLP estimates that this temporary increase will allow 28,400 additional affordable rental homes to be constructed/rehabilitated over what would have been possible under the prior law. While this is only a fraction of the estimated 235,000 affordable unit 10-year deficit created by tax reform (according to Novogradac), housing advocates are hopeful the law will be further amended to make the increase permanent.
Average Income Test
After years of consideration, the Spending Plan implements the “Average Income Test” as a new option for residential rental projects to qualify as a “qualified low-income housing project” under Code Section 42(g)(1). Under prior law, in order to meet the requirements to be considered a qualified low-income housing project, either (a) 20 percent of the residential units had to be both rent-restricted and occupied by tenants with income of 50% or less of area median income or (b) 40 percent of residential units had to be both rent-restricted and occupied by tenants with income of 60% or less of area median income. The new law adds a third prong to this test, whereby a project may constitute a qualified low-income housing project if 40%3 of the residential units in such project are both rent-restricted and occupied by individuals whose income does not exceed the imputed income limitation designated by the taxpayer for the respective unit, with the average of the imputed income limitations not exceeding 60% of area median income. The taxpayer may choose to designate the imputed income limitation for each applicable unit at 20%, 30%, 40%, 50%, 60%, 70% or 80%, which designations are used to calculate the average imputed income limitation4.
The income averaging option is available to all projects making the minimum set-aside election after the enactment of the Spending Plan (March 23, 2018). However, there are numerous practical considerations regarding implementation of this amendment that will need to be addressed by the state tax credit agencies.5 Initial questions related to administration of this new option include how and when the election must be made, how the income averaging option can be applied to various types of projects, the process for designating imputed income levels (and whether the designations are changeable), and how compliance with the income averaging election will be monitored. To the extent that this new income averaging option is beneficial, the benefits are limited to projects that do not have a binding Code Section 42(g)(1) election in place already. Once an election under Code Section 42(g)(1) is made, it is irrevocable, and nothing in the new statutory language suggests that this new option is available to existing projects.
How and When to Make the Election
The Code Section 42(g)(1) election is typically made on the IRS Form 8609. Currently, IRS Form 8609 does not include an option to elect the income averaging set-aside, although this will presumably be revised in the upcoming months. In its publication “Housing Credit Income Averaging Frequently Asked Questions” (FAQ), the National Council of State Housing Agencies (NCSHA) suggests that until IRS Form 8609 is revised, states can provide taxpayers with an attachment to Form 8609 setting forth the election. Unfortunately, the FAQ is simply a recommended practice that is not binding on the IRS, so until the IRS issues administrative guidance upon which taxpayers may rely, no definitive guidance exists on this issue.
Another question that states must consider in implementing the income averaging option is whether owners that have already indicated that their development will elect either the 20/50 or 40/60 minimum set-aside (for example, in the tax credit application), or even have received a tax credit reservation or carryover allocation memorializing the election, but have not yet actually elected the same on Part II of Form 8609, can opt to switch to the income averaging option. As previously noted, once the Code Section 42(g)(1) election is made on the IRS Form 8609 it is irrevocable, but prior to that point it appears that the states may allow a different election to be made. Thus, the individual states will need to determine at what point an election becomes binding and consider how allowing changes in initial elections will affect the state’s qualified allocation plan.6
Considerations Applicable to Various Types of Projects
There are special considerations that arise in connection with the application of the income averaging regime to tax-exempt bond financed projects, projects seeking resyndication credits, multi-building projects, and projects subject to restrictions under other funding programs.
- While the Spending Plan amends Code Section 42(g)(1) to allow for income averaging, no corresponding modification was made to Code Section 142, which governs tax-exempt multifamily housing bonds and includes a parallel minimum set-aside test for qualified residential rental projects. Accordingly, bond deals must still comply with either the 20/50 or 40/60 test. These projects can elect the income averaging option for compliance with tax credit regulations, but given that they must also comply with a second set-aside test, the income averaging option may not be as attractive, as monitoring compliance with both introduces a greater level of complexity in monitoring compliance.
- As noted above, a minimum set-aside election is irrevocable once made. However, after a project’s initial compliance period, the project may be eligible for additional tax credits pursuant to a sale and rehabilitation of the project and, in connection with such a sale, may elect the income averaging minimum set-aside option. The project would still be subject to the restrictions under the original extended use agreement throughout the remainder of the extended use period and, thus, would be required to comply with multiple minimum set-asides unless the state agrees to amend the extended use agreement (or restate it in connection with a new tax credit allocation). Again, income averaging may not be advantageous in this scenario.
- When making the set-aside election, owners will need to consider whether restrictions imposed by other funding sources and programs will preclude the benefits of electing income averaging. We note that funding programs focused on extremely low-income units may not be compatible with income averaging.
- The project owner must consider whether the potential benefits of electing income averaging is worth the potentially significantly increased complexity of compliance management, and the extent to which equity investors will require additional safeguards (and economic support) in connection with any perceived increase in recapture risk.
Shifting Designations and Monitoring Headaches
The Spending Plan requires the taxpayer to designate the imputed income limit for each of the project units, but the statutory language is somewhat unclear as to whether such designations are binding and irrevocable with respect to each applicable unit or whether such designations may (a) float among the units and/or (b) change from time to time so long as the average imputed income limitation remains under 60% of area median income. In mixed-income developments, a regime that allows imputed income limitation designations to float among the units would ease the application of the next available unit and vacant unit rules, and may help to alleviate some of the increased complexity of maintaining compliance with the Average Income Test. The ability to change the imputed income limitations once designated7 might also benefit all projects in allowing for flexibility to meet current tenant demands and limiting vacancies over the course of the project’s 15-year compliance period. In the absence of guidance from the IRS expressly permitting such flexibility, though, a taxpayer (or a state tax credit agency) that assumes such flexibility is available under the statute does so at its own peril—while the statutory language is unclear, that lack of clarity does not compel a permissive interpretation.
Further guidance will be necessary from the states and/or the IRS with respect to such income “shifting” or “re-designating.” States will also need to consider the process of monitoring compliance with the income averaging minimum set-aside option, which may be more difficult if these changes are permissible.
Benefits of Income Averaging
The flexibility afforded under the income averaging option broadens the scope of those who may benefit from the low-income housing tax credit by broadening the potential base of qualifying tenants and expands the map of potential areas for development of low-income projects into areas that may have previously been challenging due to high housing costs or a sparse population of low-income renters. In addition, higher rents paid by tenants of higher income units allow developers to target a portion of the units for very low-income occupancy, with the higher available rents compensating for those of the very low-income units. This is possible because the maximum rent that may be charged with respect to a given unit is 30% of the imputed income limitation for that unit. Accordingly, a unit with an imputed income limitation of 80% of area median income with have its rent limitation determined with respect to that 80% figure. Because the income averaging election does not apply any limitations or restrictions based upon unit size, it would be possible to maximize potential rent by designating the larger units (3 or 4 BR units) in the project as having an imputed income limitation of 80% of area median income, while designating smaller units (1 BR or efficiencies) as having an imputed income limitation of 30% or 40% of area median income.
We anticipate that further guidance is forthcoming on this topic from applicable authorities, which will help taxpayers determine how income averaging can be used most effectively to their advantage and the types of projects can benefit most. While the details remain to be seen, it seems that this new option might be a useful tool in structuring low-income housing projects in certain circumstances, although it is not clear that the additional burdens and complexities will be outweighed by the potential benefits. It also remains to be seen how willing the state tax credit agencies and the equity investor market will be to embrace this new election.
With the affordable housing industry still recovering from an extended period of uncertainty regarding the ultimate scope of corporate tax reform, followed by the impact of the dramatically reduced corporate income tax rate under the TCJA, the temporary increase in each state’s tax credit ceiling under the Spending Plan is clearly beneficial to the affordable housing industry, although it is not clear that the Average Income Test will be similarly beneficial. Industry leaders will continue to lobby for bipartisan support for the ACHIA in an effort to continue to expand upon and improve the low-income housing tax credit program, although an election year and a divided Congress present large obstacles to overcome.
1. The AHCIA, originally introduced into the Senate in 2016 by Sen. Maria Cantwell and Senate Finance Committee Chairman Orren Hatch, and revised and introduced into both chambers of Congress in 2017, is a comprehensive bill aimed at addressing the increasing affordable housing crisis. AHCIA is currently co-sponsored by 38 members of the Senate and 143 members of the House, who will presumably continue to advocate for the remaining provisions to be adopted into law.
2. Prior to its amendment by the Spending Plan, Code Section 42(h)(3)(I) was originally enacted as part of the Housing Assistance Tax Act of 2008 to provide for a temporary increase in each state’s credit ceiling for calendar years 2008 and 2009.
3. For projects located in New York City, only 25% of the units must be restricted under the income averaging test.
4. Note that the average is based on the designated imputed income limitation and not the actual incomes of individual households. It should also be noted that income averaging is based only on the number of units in a project and does not take into account unit size or number of bedrooms.
5. In fact, the NCSHA FAQ suggests that there is no legal obligation for a state to allow income averaging as part of its low-income housing tax credit program, so project owners will need to consult with their applicable state credit agency to determine whether this option can be utilized.
6. We note that on March 26, 2018, the California Tax Credit Allocation Committee published proposed emergency regulation changes related to implementation of income averaging providing for a maximum average targeting of 50% of area median income for competitive projects in accordance with its current qualified allocation plan and competitive allocation point scoring system and describing the guidelines for changing the targeting elections. Other states may publish similar guidelines in coming weeks and months.
7. For example, a project with 20 units restricted to 40% of area median income and 20 units restricted to 80% of area median income may desire to shift to 10 units at 20% of AMI, 10 units at 30% of AMI, 10 units at 70% of AMI, and 10 units at 80% of AMI.