On September 29, 2025, the Treasury Department and IRS issued final regulations (TD 10036) on the recordkeeping and reporting requirements for the average income test under IRC Section 42(g)(1)(C) for purposes of the low-income housing credit.

The final regulations adopt the 2022 proposed regulations with some modifications to address reporting and timing (see Tax Alert 2022-1546).

Background

For a residential building to qualify as a low-income housing project, a certain percentage of its units must be rent-restricted and occupied by low-income tenants. There are three tests under IRC Section 42(g) that taxpayers can use to make this determination:

• The 20-50 test (at least 20% of the residential units in the project must be occupied by individuals or families whose income is 50% or less of the area median gross income (AMGI)
• The 40-60 test (at least 40% of the residential units must be occupied by individuals or families whose income is 60% or less of the AMGI)
• The average income test (at least 40% of the units must be occupied by tenants whose income does not exceed the average income limit of 60% of AMGI, with some units allowed to exceed this limit as long as the average remains at or below 60%)

In 2022, temporary and final regulations modified the average income test so it applies to rent-restricted units collectively, instead of individually. The IRS also released accompanying proposed regulations (REG-113068-22) on recordkeeping and reporting requirements for the average income test.

The proposed regulations required a taxpayer to separately identify (1) units in the qualified group of units used for satisfying the average income set-aside and (2) units in the qualified group for purposes of the applicable fractions. This information must be recorded in the taxpayer's books and records and sent to the applicable agency.

Final regulations

The final regulations follow this framework with some additional refinements, mainly to address situations where a taxpayer discovers at a later date that some units no longer qualify under the income requirements, which could change the eligibility for the credit.

Under the final regulations, a taxpayer that discovers a failure to comply with the requirements must submit a correction to the IRS within 180 days after discovery of the failure.

If the IRS discovers a failure to comply, it must provide "prompt" written notification to the taxpayer and the taxpayer must submit a correction to the IRS within the period described in Treas. Reg. Section 1.42-5(e)(4) (not to exceed 90 days from the date of the notice to the taxpayer, which may be extended up to six months if the agency determines there is good cause).

The final regulations allow taxpayers that apply the average income test to change the group of units for purposes of the test if they discover that one or more of the units no longer comply with the requirements. The Preamble specifies that permitting the submission of a revised qualified group does not authorize a taxpayer to retroactively alter income designations for any unit within a building after the conclusion of a tax year. Modifications to income designations are prohibited, even where a tenant's income would have justified a lower designation before year-end.

Implications

The final regulations provide a fair result for taxpayers and the government. If a noncompliant unit is discovered, the taxpayer has the opportunity to pass the average income test with another qualified group. This change should allow taxpayers to be more comfortable electing into income averaging and ultimately the creation of more badly-needed affordable housing units.