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In Revenue Ruling 2020-04 (released January 29, 2020), the IRS clarified how low-income housing project owners can calculate the income limits under the average income test to determine whether they set aside enough low-income housing to qualify for the IRC Section 42 credit.

For residential units to qualify as a low-income housing project, a certain percentage must be rent-restricted and occupied by low-income tenants. Previously, the tenants' gross income had to be at or below a certain percentage of the area median gross income (AMGI) under one of two minimum set-aside requirements defined in IRC Section 42(g).

The Consolidated Appropriations Act of 2018 (Pub. L. No. 115-141)(2018 Act) added a third minimum set-aside test, the average income test, which can be used in determining if the minimum set-aside requirements are met.

Background

Before the 2018 Act, IRC Section 42(g) gave owners the option of choosing between two minimum set-aside tests: (1) the 20-50 test (at least 20% of the residential units in the project must be both rent-restricted and occupied by tenants whose gross income is 50% or less of AMGI), or (2) the 40-60 test (at least 40% of the residential units in the project must be both rent-restricted and occupied by tenants whose gross income is 60% or less of AMGI).

The 2018 Act added the average income test under IRC Section 42(g)(1)(C). That test, if used, requires:

• At least 40% (25% or more if the project is in a high-cost housing area) of the residential units in the project to be both rent-restricted and occupied by tenants whose income does not exceed the imputed income limitation designated by the owner for the respective unit
• The designated imputed income limitation of any unit to be 20%, 30%, 40%, 50%, 60%, 70%, or 80% of AMGI
• The average of the designated imputed income limitations not to exceed 60% of AMGI

Calculations for average income test

Revenue Ruling 2020-04 clarifies that, in calculating the imputed income limitation for purposes of the average income test, owners should use the very low-income calculation of the Department of Housing and Urban Development (HUD), as adjusted by family size, as the basis for determining the income limits. In addition, these calculations should be consistent with Revenue Ruling 89-24, which describes how to compute the income limits under the 20-50 and 40-60 tests.

Applying these criteria, the IRS said the AMGI income limitations should be calculated as follows. In each case, the income limit is that for a very low-income family of the same size.

• 20% limit: 40% or less of the income limit
• 30% limit: 60% or less of the income limit
• 40% limit: 80% or less of the income limit
• 50% limit: equal to or less than the income limit
• 60% limit: 120% or less of the income limit
• 70% limit: 140% or less of the income limit
• 80% limit: 160% or less of the income limit

For example, if the HUD very low-income limit for a one-person household is $43,400, the low-income housing tax credit income limits would be calculated as follows:

• 20% limit: $43,400 * 40% = $17,360
• 30% limit: $43,400 * 60% = $26,040
• 40% limit: $43,400 * 80% = $34,720
• 50% limit: $43,400
• 60% limit: $43,400 * 120% = $52,080
• 70% limit: $43,400 * 140% = $60,760
• 80% limit: $43,400 * 160% = $69,440

Implications

HUD only publishes the 50% and 60% of AMGI income limits, so there has been some uncertainty as to how to calculate the wider band of income limits set forth under the average income test. The revenue ruling addresses this issue and confirms continued use of the HUD limits for very low-income families to be used as a basis for determining the full range of income limits under the average income test. While this clarification is helpful, additional guidance is still needed given the added complexities surrounding compliance with the income-averaging option, as well as for more rigid compliance monitoring practices to avoid missteps.

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