The Department of the Treasury/Internal Revenue Service published Final Regulations and Removal of Temporary Regulations regarding Section 42, Low-Income Housing Credit Average Income Test Procedures, to the Federal Register on September 30, 2025.
The average income option for minimum set-aside, also known as the Average Income Test (AIT), was introduced under the Consolidated Appropriations Act of 2018. In the years since its introduction, agencies, investors, and other stakeholders have called for clarification regarding how AIT will be managed and monitored. The IRS has drawn from comments received regarding the 2020 Proposed Regulations and the 2022 Final and Temporary regulations to provide clarification in the 2025 Final Regulations regarding: 1) The Impact of Noncompliant Unit Included in The Identified Qualified Group of Units, 2) Reporting of Two Groups of Qualified Units, and 3) The Timing of Agency Waiver.
- Impact of Noncompliant Unit Included in Identified Qualified Group of Units
Almost all projects earning tax credits maintain more than the minimum number of low-income units needed for the project to qualify for credits. The tax credit-qualified units used to demonstrate that a project has met the requirements under AIT must be identified and reported to the agency.
Commenters expressed concern that the temporary and proposed regulations left room for the possibility of creating a “cliff effect” when a non-qualified unit is identified in the group submitted. Essentially, if one unit in the identified group was noncompliant, the project could not demonstrate that it had met AIT, even if more than 40% of the units were tax-credit qualified, with income limits averaging exactly 60% of AMGI. That was not the intent of the AIT. These final regulations clearly permit the submission of a corrected qualified group of units to avoid such a “cliff.”
Please note that the Treasury Department and the IRS will permit the submission of a revised qualified group, but this does not allow for retroactive changes to income designations after a taxable year has closed. Changing an occupied unit’s income designation is not allowed, even if a tenant’s income would have supported a lower designation, and rent restriction is still a key component of unit qualification.
- Reporting of Two Groups of Qualified Units
Previous regulations asked that taxpayers report two separate groups of qualified units: one for the minimum set-aside test and one for computing the applicable fractions of the buildings in the project. Whether annual, quarterly, or monthly, State Housing Finance Agencies (SHFAs) continue to require ongoing unit status reporting that captures all necessary details to demonstrate whether both the minimum set-aside and applicable fraction are met. Furthermore, commenters suggested that reporting two separate groups of qualified units is unnecessary, as a list of all units submitted to determine the applicable fraction would also capture the information needed to determine minimum set-aside compliance. These regulations stipulate that one list can be sufficient; however, SHFAs will have the discretion to request separate lists if deemed helpful.
- Timing of Agency Waiver
Under the proposed regulations, agencies were granted the discretion to waive, in writing, any failure to comply with the recordkeeping and reporting requirements on a case-by-case basis. This waiver could be granted up to 180 days after the discovery of noncompliance. Commentors raised concerns about this waiver and the final regulations address three situations:
- if a taxpayer discovers the failure to comply, the taxpayer has up to 180 days after discovery of the failure to give the Agency a revised submission, such as a revised qualified group of units;
- if an Agency discovers a failure to comply, the Agency should provide prompt notification in a manner similar to §1.42-5(e)(2), and then the taxpayer must satisfactorily address the failure within the correction period of §1.42- 5(e)(4); or
- in all cases, an Agency has discretion to waive in writing any failure to comply with the procedural requirements of §1.42-19(c)(1), (c)(2), or (c)(3)(iv). This waiver must occur within the applicable time period (dependent on whether a taxpayer or Agency discovered failure).
Be sure to consult your project’s State Housing Finance Agency for details regarding recordkeeping, reporting, compliance monitoring, and the implementation of AIT at properties under their purview.