A short time ago I posted an article providing an overview of the new IRS final regulation on the Average Income Set-Aside. I promised to post a series of articles detailing some of the more complex elements of the final regulation and this is the second in that series. In this article, I will review the Available Unit Rule on Average Income projects.
When Congress added the Average-Income Set-Aside, it also added a new next available unit rule (AUR) for the AI test. Under this new rule, a unit ceases to be a low-income unit if two slightly different disqualifying conditions are met:
- The income of an occupant of a low-income unit increases above 140% of the greater of (i) 60% of AMGI or, (ii) the imputed income limit designated by the owner for the unit; and
- A new occupant whose income exceeds the applicable imputed income limitation occupies any other residential rental unit in the building that is of comparable or smaller size.
If the vacant unit was a low-income unit prior to becoming vacant, the unit must be occupied by a tenant who qualifies under the imputed income limit.
If the vacant unit was a market unit prior to becoming vacant, it must be designated with an income limit that will enable the project to continue to have an average imputed income of no more than 60%.
There is no major change to the AUR in the final regulation, but the language specifies that if a low-income resident has income in excess of 140% of the 60%, 70%, or 80% limit, and the next available unit in the building that is comparable or smaller in size to the over-income unit is a market unit, it must be designated with an income limit such that the average of all imputed income designations of residential units in the project does not exceed 60% of the AMGI.
Also, if multiple units are over-income at the same time, and there is a mix of low-income and market-rate units, the owner need not comply with the AUR in any specific order. Renting any available comparable or smaller vacant unit in the building to a qualified tenant maintains the low-income status of all over-income units until the next comparable or smaller unit becomes available.
A Deep-Dive into the AUR on Average-Income Projects
- For purposes of the AI set aside, a low-income unit will be considered “over-income” if the household’s income is:
- More than 140% of the 60% AMGI if the unit’s designated income limit is 20, 30, 40, 50 or 60 percent; or
- More than 140% of the unit’s designated income if the unit’s income designation is 70% or 80%.
IRS Guidance Relative to the AUR on AI Projects
- IRS Final Regulation: If multiple units are over-income at the same time, the owner need not comply with the AUR in any specific order.
- Renting any available comparable or smaller vacant unit to a qualified tenant maintains the status of all over-income units as low-income units.
- E.g., assume a 20-unit building with nine low-income units (three units at 80% of AMGI, two units at 70% of AMGI, one unit at 40% of AMGI and three units at 30% of AMGI).
- Two units are over-income, one a 30% income three-bedroom unit and another a 70% two-bedroom unit.
- The next available unit is a vacant two-bedroom market unit.
- Renting the vacant two-bedroom unit at either the 30%- or 70%-income designation will satisfy both the minimum set-aside of 40% and the average test of 60% or less.
- This is the case even if the 30% unit was the first unit to exceed the 140% income level.
- An Over-Income unit ceases to be a qualified low-income unit if any unit in the building of comparable or smaller size is occupied by a new household whose income exceeds the designated income limit of that unit – based on the designation that unit had prior to becoming vacant.
- If the unit that becomes vacant is a market unit, the owner must designate the income of the next available unit such that the project continues to meet the Average Test.
- E.g., Household A lives in a 30% designated unit and B lives in a 70% designated unit.
- A’s income exceeds 140% of the 60% AMGI, or B’s income exceeds 140% of the 70% AMGI – the AUR is now applied to the BIN.
- The income of both households goes over the 140% level at the same time.
- Assume the BIN has two market units, four 30% units, and four 70% units. The Average Test is 50%.
- A market unit is rented at the 30% AMGI, maintaining four 30% and four 70% units – the 30% over-income unit now becomes a market unit, and the Average Test is still 50%.
- But – what if instead of renting the market unit to a designated 30% household, the owner rents the unit to a designated 50% household and makes the 30% over-income unit a market unit?
- Result: There are now two market units, one 50% unit, three 30% units, and four 70% units (one of which is over-income). The Average Test is now 52.5% – the project still qualifies under the Average Test but has one less 30% unit.
- The AUR requirement is met but this could be a LURA violation.
The preceding example is why many HFAs may not allow mixed-income projects to select the AI Minimum Set-Aside.
Clearly, the additional complexity relative to the AUR on Average Income properties should give owners pause prior to developing mixed-income buildings with the Average-Income set-aside. However, with good management and tracking procedures, any difficulties can be overcome, and the benefits of a mixed-income project realized. One final word of warning though; as the example above illustrates, owners may be able to replace lower designated units with higher designations when complying with the AUR. While this would increase cash flow due to higher rents, it could very well run afoul of the property LURA (extended use agreement) which may stipulate a required number of units at each income level. At the very least, before taking such a step owners should confirm that no state requirements would be violated and that investors are on board with the change.