[Federal Register Volume 85, Number 211 (Friday, October 30, 2020)]
[Proposed Rules]
[Pages 68816-68822]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-20221]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-119890-18]
RIN 1545-BO92


Section 42, Low-Income Housing Credit Average Income Test 
Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations setting forth 
guidance on the average income test under section 42(g)(1)(C) of the 
Internal Revenue Code (Code) for purposes of the low-income housing 
credit. These proposed regulations affect owners of low-income housing 
projects, tenants in those projects, and State or local housing credit 
agencies that administer the low-income housing credit.

DATES: Written (including electronic) comments must be received by 
December 29, 2020.

ADDRESSES: Commenters are strongly encouraged to submit public comments 
electronically. Submit electronic submissions via the Federal 
eRulemaking Portal at www.regulations.gov (indicate IRS and REG-104591-
18) by following the online instructions for submitting comments. Once 
submitted to the Federal eRulemaking Portal, comments cannot be edited 
or withdrawn. The IRS expects to have limited personnel available to 
process public comments that are submitted on paper through the mail. 
Until further notice, any comments submitted on paper will be 
considered to the extent practicable. The Department of the Treasury 
(Treasury Department) and the IRS will publish for public availability 
any comment submitted electronically, and to the extent practicable on 
paper, to its public docket.

FOR FURTHER INFORMATION CONTACT: Concerning these proposed regulations, 
Dillon Taylor or Michael J. Torruella Costa at (202) 317-4137; 
concerning submissions of comments, Regina L. Johnson at (202) 317-6901 
(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under section 42 of the Code.
    The Tax Reform Act of 1986, Public Law 99-514, 100 Stat. 2085 (1986 
Act) created the low-income housing credit under section 42 of the 
Code. Section 42(a) provides that the amount of the low-income housing 
credit for any taxable year in the credit period is an amount equal to 
the applicable percentage of the qualified basis of each qualified low-
income building.
    Section 42(c)(1)(A) provides that the qualified basis of any 
qualified low-income building for any taxable year is an amount equal 
to (i) the applicable fraction (determined as of the close of the 
taxable year) of (ii) the eligible basis of the building (determined 
under section 42(d)). Sections 42(c) and 42(d) define applicable 
fraction and eligible basis. Section 42(d)(1) and (2) define the 
eligible basis of a new building or an existing building, respectively.
    Section 42(c)(2) defines a qualified low-income building as any 
building which is part of a qualified low-income housing project at all 
times during the compliance period (that is, the period of 15 taxable 
years beginning with the first taxable year of the credit period) and 
to which the amendments made by section 201(a) of the 1986 Act apply 
(generally property placed in service after December 31, 1986, in 
taxable years ending after that date). To qualify as a low-income 
housing project, one of the section 42(g) minimum set-aside tests, as 
elected by the taxpayer, must be satisfied.
    Prior to the enactment of the Consolidated Appropriations Act of 
2018, Public Law 115-141, 132 Stat. 348 (2018 Act), section 42(g) set 
forth two minimum set-aside tests that a taxpayer may elect with 
respect to a low-income housing project, known as the 20-50 test and 
the 40-60 test. Under the 20-50 test, at least 20 percent of the 
residential units in the project must be both rent-restricted and 
occupied by tenants whose gross income is 50 percent or less of the 
area median gross income (AMGI). Section 42(g)(1)(A). Under the 40-60 
test, at least 40 percent of the residential units in the project must 
be both rent-restricted and occupied by tenants whose gross income is 
60 percent or less of AMGI. Section 42(g)(1)(B).
    Section 103(a) of Division T of the 2018 Act added section 
42(g)(1)(C) to the Code to provide a third minimum set-aside test that 
a taxpayer may elect with respect to a low-income housing project: The 
average income test. Section 42(g)(1)(C)(i) provides that, a project 
meets the minimum requirements of the average income test if 40 percent 
or more (25 percent or more in the case of a project described in 
section 142(d)(6)) of the residential units in the project are both 
rent-restricted and occupied by tenants whose income does not exceed 
the imputed income limitation designated by the taxpayer with respect 
to the respective unit. Section 42(g)(1)(C)(ii)(I) and (III) provides 
that the taxpayer must designate the imputed income limitation for each 
unit and the designated imputed income limitation of any unit must be 
20, 30, 40, 50, 60, 70, or 80 percent of AMGI. Section 
42(g)(1)(C)(ii)(II) provides that the average of the imputed income

[[Page 68817]]

limitations designated by the taxpayer for each unit must not exceed 60 
percent of AMGI.
    Generally, under section 42(g)(2)(D)(i), if the income of the 
occupant of a low-income unit rises above the income limitation, the 
unit continues to be treated as a low-income unit if the income of the 
occupant initially met the income limitation and the unit continues to 
be rent-restricted. Section 42(g)(2)(D)(ii), however, provides an 
exception to the general rule in case of the 20-50 test or the 40-60 
test. Under this exception, the unit ceases to be treated as a low-
income unit when two conditions occur. The first condition is that the 
income of an occupant of a low-income unit increases above 140 percent 
of the imputed income limitation applicable to the unit under section 
42(g)(1) (applicable income limitation). The second condition is that a 
new occupant, whose income exceeds the applicable income limitation, 
occupies any residential unit in the building of a comparable or 
smaller size. In the case of a deep rent skewed project described in 
section 142(d)(4)(B), ``170 percent'' is substituted for ``140 
percent'' in applying the applicable income limitation under section 
42(g)(1), and the second condition is that any low-income unit in the 
building is occupied by a new resident whose income exceeds 40 percent 
of AMGI. Section 42(g)(2)(D)(iv). The exception contained in section 
42(g)(2)(D)(ii) is referred to as the ``next available unit rule.'' See 
also Sec.  1.42-15 of the Income Tax Regulations.
    Section 103(b) of Division T of the 2018 Act added section 
42(g)(2)(D)(iii), (iv) and (v) to the Code to provide a new next 
available unit rule for situations in which the taxpayer has elected 
the average income test. Under this new next available unit rule, a 
unit ceases to be a low-income unit if two conditions are met. The 
first condition is whether the income of an occupant of a low-income 
unit increases above 140 percent of the greater of (i) 60 percent of 
AMGI, or (ii) the imputed income limitation designated by the taxpayer 
with respect to the unit (applicable imputed income limitation). The 
second condition is whether any other residential rental unit in the 
building that is of a size comparable to, or smaller than, that unit is 
occupied by a new tenant whose income exceeds the applicable imputed 
income limitation. If the new tenant occupies a unit that was taken 
into account as a low-income unit prior to becoming vacant, the 
applicable imputed income limitation is the limitation designated with 
respect to the unit. If the new tenant occupies a market-rate unit, the 
applicable imputed income limitation is the limitation that would have 
to be designated with respect to the unit in order for the project to 
continue to maintain an average of the designations of 60 percent of 
AMGI or lower.
    In the case of a deep rent skewed project described in section 
142(d)(4)(B) for which the taxpayer elects the average income test, 
``170 percent'' is substituted for ``140 percent'' in applying the 
applicable imputed income limitation, and the second condition is that 
any low-income unit in the building is occupied by a new resident whose 
income exceeds the lesser of 40 percent of AMGI or the imputed income 
limitation designated with respect to the unit under section 
42(g)(1)(C)(ii)(I). Section 42(g)(2)(D)(iv).
    Under section 42(g), once a taxpayer elects to use a particular 
set-aside test with respect to a low-income housing project, that 
election is irrevocable. Thus, if a taxpayer had previously elected to 
use the 20-50 test under section 42(g)(1)(A) or the 40-60 test under 
section 42(g)(1)(B) with respect to a low-income housing project, the 
taxpayer may not subsequently elect to use the average income test 
under section 42(g)(1)(C) with respect to that low-income housing 
project. Section 42(g)(4) provides generally that section 142(d)(2) 
applies for purposes of determining whether any project is a qualified 
low-income housing project and whether any unit is a low-income unit.
    Section 42(m)(1) provides that the owners of an otherwise-
qualifying building are not entitled to the housing credit dollar 
amount that is allocated to the building unless, among other 
requirements, the allocation is pursuant to a qualified allocation plan 
(QAP). A QAP provides standards by which a State or local housing 
credit agency (Agency) is to make these allocations. Under Sec.  1.42-
5(a)(1), a QAP must contain a procedure that the Agency will follow in 
monitoring noncompliance.

Explanation of Provisions

I. Proposed Sec.  1.42-15, Next Available Unit Rule for the Average 
Income Test

    The proposed regulations update the next available unit provisions 
in Sec.  1.42-15 to reflect the new set-aside based on the average 
income test and to take into account section 42(g)(2)(D)(iii), (iv) and 
(v). In situations where multiple units are over-income at the same 
time in an average-income project that has a mix of low-income and 
market-rate units, these regulations provide that a taxpayer need not 
comply with the next available unit rule in a specific order. Instead, 
renting any available comparable or smaller vacant unit to a qualified 
tenant maintains the status of all over-income units as low-income 
units until the next comparable or smaller unit becomes available (or, 
in the case of a deep rent skewed project, the next low-income unit 
becomes available). For example, in a 20-unit building with 9 low-
income units (3 units at 80 percent of AMGI; 2 units at 70 percent of 
AMGI; 1 unit at 40 percent of AMGI; and 3 units at 30 percent of AMGI), 
if there are two over-income units, one a 30 percent income 3-bedroom 
unit and another a 70 percent 2-bedroom unit, and the next available 
unit is a vacant 2-bedroom market-rate unit, renting the vacant 2-
bedroom unit to occupants at either the 30 or 70 percent income 
limitation would satisfy both the minimum set-aside of 40 percent and 
the average test of 60 percent or lower required by section 
42(g)(1)(C).

II. Proposed Sec.  1.42-19, Average Income Test

A. In General
    The proposed regulations provide that a project for residential 
rental property meets the requirements of the average income test under 
section 42(g)(1)(C) if 40 percent or more (25 percent or more in the 
case of a project described in section 142(d)(6)) of the residential 
units in the project are both rent-restricted and occupied by tenants 
whose income does not exceed the imputed income limitation designated 
by the taxpayer with respect to the respective unit. The average of the 
designated imputed income limitations of the low-income units in the 
project must not exceed 60 percent of AMGI.
B. Designation of Imputed Income Limitations
    Section 42(g)(1)(C)(ii) provides special rules relating to the 
income limitations applicable in the average income test. Specifically, 
it provides that the taxpayer must designate the imputed income 
limitation for each unit taken into account under the average income 
test. Further, the imputed income limitation of any unit designated 
must be 20, 30, 40, 50, 60, 70, or 80 percent of AMGI.
    The proposed regulations provide that a taxpayer must designate the 
imputed income limitation of each unit taken into account under the 
average income test in accordance with: (1) Any procedures established 
by the IRS in forms, instructions, or publications or in

[[Page 68818]]

other guidance published in the Internal Revenue Bulletin pursuant to 
Sec.  601.601(d)(2)(ii)(b); and (2) any procedures established by the 
Agency that has jurisdiction over the low-income housing project that 
contains the units to be designated, to the extent that those Agency 
procedures are consistent with any IRS guidance and these regulations. 
After the enactment of the 2018 Act, commenters have specifically asked 
that Agencies be provided this flexibility, and the Treasury Department 
and the IRS agree that Agencies should generally be able to establish 
designation procedures that accommodate their needs. Several commenters 
suggested allowing the Agencies, when they consider it necessary, to 
require income recertifications, to set compliance testing periods, or 
to adjust compliance monitoring fees to reflect the additional costs 
associated with monitoring income averaging. These proposed regulations 
do not change existing levels of flexibility on those issues.
C. Method and Timing of Unit Designation
    The Code does not specify the manner by which taxpayers must 
designate the imputed income limitation of units for purposes of the 
average income test. Designation of the imputed income limitation with 
respect to a unit is, first, for Agencies to evaluate the proper mix of 
units in a project in making housing credit dollar amount allocations 
consistent with the State policies and procedures set forth in the 
QAPs, and, second, to carry out their compliance-monitoring 
responsibilities. For these reasons, the proposed regulations provide 
that the taxpayers should designate the units in accordance with the 
Agency procedures relating to such designations, provided that the 
Agency procedures are consistent with any requirements and procedures 
relating to unit designation that the IRS may set forth in its forms 
and publications and other guidance. Further, to promote certainty, the 
proposed regulations provide that the taxpayers must complete the 
initial designation of all of the units taken into account for the 
average income test as of the close of the first taxable year of the 
credit period. In addition, the proposed regulations provide that no 
change to the designated imputed income limitations may be made.
D. Requirement To Maintain 60 Percent AMGI Average Test and Opportunity 
To Take Mitigating Actions
    A low-income housing project must meet the requirements of the 
elected set-aside test for each taxable year. For a project electing 
the average income test, in addition to the project containing at least 
40 percent low-income units, the designated imputed income limitations 
of the project must meet the requirement of an average test. That is, 
the average of the designated imputed income limitations of all low-
income units (including units in excess of the minimum 40 percent set-
aside) must be 60 percent of AMGI or lower (60-percent or lower average 
test). Regardless of their other attributes, residential units that are 
not included in the computation of the average do not count as low-
income units. Consistent with the application of the 20-50 test and 40-
60 test, the statutory requirements of a set-aside test do not change 
from year to year. Accordingly, in each taxable year, the average of 
all of the designations must be 60 percent of AMGI or lower.
    The Treasury Department and the IRS recognize that, in some 
situations, the average income requirement may magnify the adverse 
consequences of a single unit's failure to maintain its status as a 
low-income unit. Assume, for example, a 100 percent low-income project 
in which a single unit is taken out of service. Under the 20-50 or 40-
60 set-asides, the project remains a qualified low-income housing 
project even though the reduction in qualified basis may trigger a 
corresponding amount of recapture. By contrast, under the average 
income set-aside, if the failing unit has a designated imputed income 
limitation that is less than 60 percent of AMGI, the average of the 
limitations without that unit may now be more than 60 percent. In the 
absence of some relief provision under the average income test, the 
entire project would fail, and the taxpayer would experience a 
correspondingly large recapture.
    Because there is no indication that the statute intended such a 
stark disparity between the average income set-aside and the existing 
20-50 and 40-60 set asides, the proposed regulations provide for 
certain mitigating actions. In most situations, if the taxpayer takes a 
mitigating action within 60 days of the close of a year for which the 
average income test might be violated, the taxpayer avoids total 
disqualification of the project and significantly reduces the amount of 
recapture. See part II.F. of this Explanation of Provisions.
    Responding to that same concern after the enactment of the 2018 
Act, some commenters asked that Agencies be provided a specific grant 
of authority to establish procedures and policies related to the 
average income set-aside that could reduce the risk of failure of an 
entire project. For example, some commenters asked that Agencies be 
allowed to establish rules permitting owners to alter the imputed 
income limitations designated for particular units (presumably by 
reducing income limitations when needed to maintain a compliant average 
and then later raising limitations to prevent a permanent reduction in 
the aggregate maximum gross rents from the project). As described in 
part II.C. of this Explanation of Provisions, these proposed 
regulations do not permit designated imputed income limitations to be 
changed. Other commenters proposed allowing owners to take protective 
steps similar to those that are provided in the proposed regulations.
E. Results Following an Opportunity To Take Mitigating Actions
    The proposed regulations provide that, after any mitigating 
actions, if, prior to the end of the 60th day following the year in 
which the project would otherwise fail the 60-percent or lower average 
test, the project satisfies all other requirements to be a qualified 
low-income housing project, then as a result of the mitigating action, 
the project is treated as having satisfied the 60-percent or lower 
average test at the close of the immediately preceding year. However, 
if no mitigating actions are taken, the project fails to be a qualified 
low-income housing project as of the close of the year in which the 
project fails the average income test.
F. Description of Mitigating Actions
    The proposed regulations describe two possible mitigating actions. 
First, the taxpayer may convert one or more market-rate units to low-
income units. Immediately prior to becoming a low-income unit, that 
unit must be vacant or occupied by a tenant who qualifies for residence 
in a low-income unit (or units) and whose income is not greater than 
the new imputed income limitation of that unit (or units).
    Alternatively, the taxpayer may identify one or more low-income 
units as ``removed'' units. A unit may be a removed unit only if it 
complies with all the requirements of section 42 to be a low-income 
unit.
G. Tax Treatment of Removed Units
    The proposed regulations provide that a removed unit is not 
included in computing the average of the imputed income limitations of 
the low-income units under the 60-percent or lower average test. If the 
absence of one or more removed units from the computation causes fewer 
than 40 percent (or, if applicable, fewer than 25

[[Page 68819]]

percent) of the residential units to be taken into account in computing 
the average, the project fails to be a qualified low-income housing 
project. In addition, a removed unit is not treated as a low-income 
unit (or units) for purposes of credit calculation. On the other hand, 
for purposes of the recapture provisions of section 42(j), a removed 
unit is treated the same as a low-income unit, and thus the act of 
identifying a removed unit does not trigger recapture (unless the 
identification reduces the low-income units below 40 percent of the 
project).
H. Request for Comments on an Alternative Mitigating Action Approach
    Recognizing that this approach of mitigating actions may in certain 
cases cause a project to have less than 40 percent of low-income units 
and, thereby, to fail the average income test, the Treasury Department 
and the IRS request comments on an alternative mitigating approach. 
Under this alternative mitigating approach, in the event that the 
average test rises above 60 percent of AMGI as of the close of a 
taxable, due to a low-income unit or units ceasing to be treated as a 
low-income unit or units, the taxpayer may take the mitigating actions 
of redesignating the imputed income limitation of a low-income unit to 
return the average test to 60 percent of AMGI or lower. If, under this 
approach, a redesignation causes a low-income unit to be an over-income 
unit as defined in Sec.  1.42-15(a), the taxpayer would be required to 
apply the next available unit rule applicable to the average income 
test.

Proposed Applicability Date

    The amendments to the next available unit regulations in Sec.  
1.42-15 are proposed to apply to occupancy beginning 60 or more days 
after the date those regulations are published as final regulations in 
the Federal Register. The average income test regulations in Sec.  
1.42-19 are proposed to apply to taxable years beginning after the date 
those regulations are published as final regulations in the Federal 
Register. Taxpayers, however, may rely on the proposed amendments to 
Sec.  1.42-15 for occupancy beginning after October 30, 2020 and on or 
before 60 days after the date those regulations are published as final 
regulations in the Federal Register, provided the taxpayer follows the 
rules in proposed Sec.  1.42-15 in their entirety, and in a consistent 
manner. Taxpayers may also rely on proposed Sec.  1.42-19 for taxable 
years beginning after October 30, 2020 and on or before the date those 
regulations are published as final regulations in the Federal Register, 
provided the taxpayer follows the rules in proposed Sec.  1.42-19 in 
their entirety, and in a consistent manner.

Special Analyses

    This regulation is not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Department of the Treasury and the Office of 
Management and Budget regarding review of tax regulations.
    Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it 
is hereby certified that this regulation will not have a significant 
economic impact on a substantial number of small entities. This 
certification is based on the fact that, prior to the publication of 
this regulation and before the enactment of the 2018 Act, taxpayers 
were already required to satisfy either the 20-50 test or the 40-60 
test, as elected by the taxpayer, in order to qualify as a low-income 
housing project. The 2018 Act added a third minimum set-aside test, the 
average income test, that taxpayers may elect. This regulation sets 
forth requirements for the average income test, and the costs 
associated with the average income test are similar to the costs 
associated with the 20-50 test and 40-60 test. Accordingly, the 
Secretary certifies that this regulation will not have a significant 
economic impact on a substantial number of small entities.
    Pursuant to section 7805(f) of the Internal Revenue Code, these 
regulations will be submitted to the Chief Counsel for the Office of 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

Comments and Requests for a Public Hearing

    Before these proposed amendments to the regulations are adopted as 
final regulations, consideration will be given to comments that are 
submitted timely to the IRS as prescribed in the preamble under the 
ADDRESSES section. The Treasury Department and the IRS request comments 
on all aspects of the proposed regulations. Any electronic comments 
submitted, and to the extent practicable any paper comments submitted, 
will be made available at www.regulations.gov or upon request.
    A public hearing will be scheduled if requested in writing by any 
person who timely submits electronic or written comments. Requests for 
a public hearing are also encouraged to be made electronically. If a 
public hearing is scheduled, notice of the date and time for the public 
hearing will be published in the Federal Register. Announcement 2020-4, 
2020-17 IRB 1, provides that until further notice, public hearings 
conducted by the IRS will be held telephonically. Any telephonic 
hearing will be made accessible to people with disabilities.

Drafting Information

    The principal authors of these regulations are Dillon Taylor and 
Michael J. Torruella Costa, Office of the Associate Chief Counsel 
(Passthroughs and Special Industries). However, other personnel from 
the Treasury Department and the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding in 
numerical order an entry for Sec.  1.42-19 to read in part as follows:

    Authority:  26 U.S.C. 7805 * * *

    Section 1.42-19 also issued under 26 U.S.C. 42(n).
* * * * *
0
Par. 2. Section 1.42-0 is amended by:
0
1. In Sec.  1.42-15:
0
i. Revising the entry for (c).
0
ii. Adding entries for (c)(1) and (2) and (c)(2)(i) through (iv).
0
iii. Revising the entry for (i).
0
iv. Adding entries for (i)(1) and (2).
0
2. Adding Sec.  1.42-19.
    The revisions and additions read as follows:


Sec.  1.42-0  Table of contents.

* * * * *
Sec.  1.42-15 Available unit rule.

* * * * *
    (c) Exceptions.
    (1) Rental of next available unit in case of the 20-50 test or 
40-60 test.
    (2) Rental of next available unit in case of the average income 
test.
    (i) Basic rule.
    (ii) No requirement to comply with the next available unit rule 
in a specific order.
    (iii) Deep rent skewed projects.
    (iv) Limitation.
* * * * *
    (i) Applicability dates.
    (1) In general.
    (2) Applicability dates under the average income test.
* * * * *
Sec.  1.42-19 Average income test.

    (a) In general.

[[Page 68820]]

    (b) Designated of imputed income limitations.
    (1) 10-percent increments.
    (2) Method of designation.
    (3) Timing of designation.
    (i) No subsequent change to imputed income limitations.
    (ii) Converted market-rate units.
    (c) Opportunity to take mitigating actions.
    (d) Results following an opportunity to take mitigating actions.
    (e) Mitigating actions.
    (1) Conversion of a market-rate unit.
    (2) Removing low-income units from the average income 
computation.
    (f) Tax treatment of removed units.
    (1) Status of the project.
    (2) Recapture.
    (3) Amount of credit.
    (4) Long-term commitment.
    (g) Examples.
    (1) Example 1.
    (i) Facts.
    (ii) Analysis.
    (2) Example 2.
    (i) Facts.
    (ii) Analysis.
    (A) Average income test.
    (B) Recapture.
    (C) Restoration of habitability and of qualified basis.
    (h) Applicability dates.

0
Par. 3. Section 1.42-15 is amended by:
0
1. Revising the definition of Over-income unit in paragraph (a).
0
2. Revising the heading for paragraph (c).
0
3. Designating the text of paragraph (c) as paragraph (c)(1) and adding 
a heading for newly designated paragraph (c)(1).
0
4. Adding paragraph (c)(2).
0
5. Revising paragraph (i).
    The revisions and additions read as follows:


Sec.  1.42-15  Available unit rule.

    (a) * * *
    Over-income unit means, in the case of a project with respect to 
which the taxpayer elects the requirements of section 42(g)(1)(A) (20-
50 test) or section 42(g)(1)(B) (40-60 test), a low-income unit in 
which the aggregate income of the occupants of the unit increases above 
140 percent of the applicable income limitation under section 
42(g)(1)(A) and (B), or above 170 percent of the applicable income 
limitation for deep rent skewed projects described in section 
142(d)(4)(B). In the case of a project with respect to which the 
taxpayer elects the requirements of section 42(g)(1)(C) (average income 
test), over-income unit means a low-income unit in which the aggregate 
income of the occupants of the unit increases above 140 percent (170 
percent in case of deep rent skewed projects described in section 
142(d)(4)(B)) of the greater of 60 percent of area median gross income 
or the imputed income limitation designated with respect to the unit 
under Sec.  1.42-19(b).
* * * * *
    (c) Exceptions--(1) Rental of next available unit in case of the 
20-50 test or 40-60 test.* * *
    (2) Rental of next available unit in case of the average income 
test--(i) Basic rule. In the case of a project with respect to which 
the taxpayer elects the average income test, if a unit becomes an over-
income unit within the meaning of paragraph (a) of this section, that 
unit ceases to be a low-income unit if--
    (A) Any residential rental unit (of a size comparable to, or 
smaller than, the over-income unit) is available, or subsequently 
becomes available, in the same low-income building; and
    (B) That available unit is occupied by a new resident whose income 
exceeds the limitation described in paragraph (c)(2)(iv) of this 
section.
    (ii) No requirement to comply with the next available unit rule in 
a specific order. In situations where multiple units in a building are 
over-income units at the same time, it is not necessary for a taxpayer 
to comply with the rule in this section (next available unit rule) in a 
specific order.
    (iii) Deep rent skewed projects. In the case of a project described 
in section 142(d)(4)(B) with respect to which the taxpayer elects the 
average income test, if a unit becomes an over-income unit within the 
meaning of paragraph (a) of this section, that unit ceases to be a low-
income unit if--
    (A) Any low-income unit is available, or subsequently becomes 
available, in the same low-income building; and
    (B) That unit is occupied by a new resident whose income exceeds 
the lesser of 40 percent of area median gross income or the imputed 
income limitation designated with respect to that unit.
    (iv) Limitation. For purposes of paragraph (c)(2) of this section 
(basic next available unit rule for the average income test), the 
limitation described in this paragraph (c)(2)(iv) is--
    (A) In the case of a unit that was taken into account as a low-
income unit prior to becoming vacant, the imputed income limitation 
designated with respect to that available unit for the average income 
test under Sec.  1.42-19(b); and
    (B) In the case of any other unit, the highest imputed income 
limitation that could be designated with respect to that available unit 
under Sec.  1.42-19(e)(1), in order for the project to continue to meet 
the requirements of Sec.  1.42-19(a)(3) (60 percent of AMGI or less).
* * * * *
    (i) Applicability dates--(1) In general. Except as provided in 
paragraph (i)(2) of this section, this section applies to leases 
entered into or renewed on and after September 26, 1997.
    (2) Applicability dates under the average income test. The second 
sentence of the definition of over-income unit in paragraph (a) of this 
section and paragraph (c)(2) of this section apply to occupancy 
beginning 60 or more days after [date these regulations are published 
as final regulations in the Federal Register].
0
Par. 4. Section 1.42-19 is added to read as follows:


Sec.  1.42-19   Average income test.

    (a) In general. A project for residential rental property meets the 
requirements of section 42(g)(1)(C) (average income test) if--
    (1) 40 percent or more (25 percent or more in the case of a project 
described in section 142(d)(6)) of the residential units in the project 
are both rent-restricted and occupied by individuals whose income does 
not exceed the imputed income limitation designated by the taxpayer 
with respect to the respective unit;
    (2) The taxpayer designates these imputed income limitations in the 
manner provided by paragraph (b) of this section; and
    (3) The average of the imputed income limitations of the low-income 
units in the project does not exceed 60 percent of area median gross 
income (AMGI).
    (b) Designation of imputed income limitations--(1) 10-percent 
increments. The designated imputed income limitation of any unit must 
be 20 percent, 30 percent, 40 percent, 50 percent, 60 percent, 70 
percent, or 80 percent of AMGI.
    (2) Method of designation. The taxpayer must designate the imputed 
income limitation of each unit in accordance with--
    (i) Any procedures established by the Internal Revenue Service 
(IRS) in forms, instructions, or publications or in other guidance 
published in the Internal Revenue Bulletin pursuant to Sec.  
601.601(d)(2)(ii)(b) of this chapter; and
    (ii) Any procedures established by the State or local housing 
credit agency (Agency) that has jurisdiction over the low-income 
housing project that contains the units to be designated, to the extent 
that those Agency procedures are consistent with the requirements of 
paragraph (b)(2)(i) of this section.
    (3) Timing of designation. Except as provided in paragraph 
(b)(3)(ii) of this section, not later than the close of the first 
taxable year of the credit period,

[[Page 68821]]

the taxpayer must designate the imputed income limitation of each unit 
taken into account for purposes of paragraph (a) of this section.
    (i) No subsequent change to imputed income limitations. No change 
to the designated imputed income limitations may be made. Even if the 
taxpayer elects to identify a low-income unit as a removed unit under 
paragraph (e)(2) of this section, the designated imputed income 
limitation of the unit is not changed. If a designation is removed, the 
unit ceases to be a low-income unit.
    (ii) Converted market-rate units. If a residential unit that was 
not a low-income unit is converted to a low-income unit, the 
designation of the imputed income limitation for that unit must take 
place on or before the 60th day after the unit is to be treated as a 
low-income unit. See paragraphs (b)(1) and (2) of this section for 
rules regarding designation.
    (c) Opportunity to take mitigating actions. The taxpayer may take 
one or more of the mitigating actions described in paragraph (e)(1) or 
(2) of this section if--
    (1) At the close of a taxable year (failing year), one or more low-
income units have ceased to qualify as low-income units; and
    (2) This cessation causes the project of which they are a part to 
fail to satisfy the requirement in paragraph (a)(3) of this section 
(regarding the average of the imputed income limitations of the low-
income units).
    (d) Results following an opportunity to take mitigating actions. 
(1) After any mitigating actions, if, prior to the end of the 60th day 
following the failing year, the project satisfies the requirements to 
be a low-income housing project (including satisfaction of the 
requirement in paragraph (a)(3) of this section), then paragraph (a)(3) 
of this section is treated as having been satisfied at the close of the 
failing year.
    (2) If paragraph (d)(1) of this section does not apply, the project 
fails to be a qualified low-income project on the close of the failing 
year.
    (e) Mitigating actions--(1) Conversion of a market-rate unit. The 
taxpayer may convert to low-income status a unit that is not currently 
a low-income unit. Immediately prior to becoming a low-income unit, the 
unit must be vacant or occupied by a tenant who qualifies for residence 
in a low-income unit and whose income is not greater than the imputed 
income limitation designated by the taxpayer for that unit. This 
inclusion of conversions as mitigating actions is without prejudice to 
the permissibility of conversions in other contexts.
    (2) Removing low-income units from the average income computation. 
The taxpayer may identify one or more residential units as removed 
units. A unit may be a removed unit only if it complies with all 
requirements of section 42 to be a low-income unit. Status as a removed 
unit may be ended by the taxpayer at any time. Identification of a 
removed unit and termination of that identification must be effected as 
provided by the IRS in forms, publications, and guidance published in 
the Internal Revenue Bulletin pursuant to Sec.  601.601(d)(2)(ii)(b) of 
this chapter. In the absence of any such IRS requirements, the 
identification and termination must be made in accordance with any 
Agency procedures.
    (f) Tax treatment of removed units--(1) Status of the project. A 
removed unit is not taken into account under paragraph (a)(3) of this 
section in computing the average of the imputed income limitations of 
the low-income units. If the absence of one or more removed units from 
the computation causes fewer than 40 percent (or, if applicable, fewer 
than 25 percent) of the residential units to be taken into account in 
computing the average, the project fails to be a qualified low-income 
housing project.
    (2) Recapture. For purposes of applying section 42(j), removed 
units are taken into account in the same manner as low-income units. 
Thus, during the compliance period, a unit's status as a removed unit 
does not reduce the applicable fraction of section 42(c)(1)(B) and thus 
does not reduce qualified basis for purposes of recapture under section 
42(j).
    (3) Amount of credit. For purposes of section 42(a), removed units 
are not taken into account as low-income units. Thus, during the credit 
period, a unit's status as a removed unit reduces the applicable 
fraction--and thus reduces qualified basis--for purposes of calculating 
the taxpayer's annual credit amount.
    (4) Long-term commitment. For purposes of applying section 
42(h)(6)(B)(i) to any taxable year after the credit period, removed 
units are not taken into account as low-income units.
    (g) Examples. The operation of this section is illustrated by the 
following examples.
    (1) Example 1--(i) Facts. (A) A single-building housing project 
received an allocation of housing credit dollar amount. The taxpayer 
who owns the project elects the average income test, intending for the 
5-unit building to have100 percent low-income occupancy. The taxpayer 
properly and timely designates the imputed income limitations for the 5 
units as follows: 2 units at 40 percent of AMGI; 1 unit at 60 percent 
of AGMI; and 2 units at 80 percent of AMGI.

                    Table 1 to Paragraph (g)(1)(i)(A)
------------------------------------------------------------------------
                                       Imputed income limitation of the
              Unit No.                               unit
------------------------------------------------------------------------
1..................................  80 percent of AMGI.
2..................................  80 percent of AMGI.
3..................................  60 percent of AMGI.
4..................................  40 percent of AMGI.
5..................................  40 percent of AMGI.
------------------------------------------------------------------------

    (B) In the first taxable year of the credit period (Year 1), the 
project is fully leased and occupied.
    (ii) Analysis. (A) The average of the imputed income limitations of 
the units is 60 percent of AMGI calculated as follows: (2 x 40% + 1 x 
60% + 2 x 80%)/5 = 60%.
    (B) Thus, the income limitations satisfy the requirement in 
paragraph (a)(3) of this section that the average of the designated 
imputed income limitations of the low-income units in the project does 
not exceed 60% of AMGI.
    (2) Example 2--(i) Facts. Assume the same facts as in paragraph 
(g)(1) of this section (Example 1). In Year 2, Unit #4 becomes 
uninhabitable. (Unit #4 has a designated imputed income limitation of 
40 percent of AMGI.) Because all of the units in the project are low-
income units, converting a market-rate unit to a low-income unit is not 
an available mitigating action. Within 60 calendar days following the 
close of Year 2, the taxpayer identifies Unit #2 as a removed unit. 
(Unit #2 has a designated imputed income limitation of 80 percent of 
AMGI.) Repair work on Unit #4 is completed in Year 4, and the taxpayer 
then ends the status of Unit #2 as a removed unit.
    (ii) Analysis. During Year 2, Unit #4 is not a low-income unit 
because it is not suitable for occupancy under section 42(i)(3)(B). In 
the absence of any mitigating action, the average of the imputed income 
limitations of the units at the close of Year 2 would be 65 percent of 
AMGI. That average would be calculated as follows: (1 x 40% + 1 x 60% + 
2 x 80%)/4 = 65%. Under paragraph (d)(2) of this section, unless 
effective mitigating action is taken not later than the 60th calendar 
day following the close of Year 2, the project fails to be a qualified 
low-income housing project because it fails to satisfy paragraph (a)(3) 
of this section. As described in the facts in paragraph (g)(2)(i) of 
this section, however, the

[[Page 68822]]

taxpayer takes the mitigating action in paragraph (e)(2) of this 
section. That action has the following results:
    (A) Average income test. Under paragraph (f)(2) of this section, 
the identification of Unit #2 as a removed unit causes that unit not to 
be taken into account in computing the average of the imputed income 
limitations of the low-income units. Unit #4 is also not taken into 
account because it is no longer a low-income unit. Therefore, the 
calculation under paragraph (a)(3) of this section as of the close of 
Years 2 and 3 is as follows: (1 x 40% + 1 x 60% + 1 x 80%)/3 = 60%. 
Thus, for those years, the project satisfies the average income test 
because, for purposes of that test, at least 40 percent of the units 
are taken into account as low-income units and the average of the 
imputed income limitations of those units does not exceed 60% of AMGI.
    (B) Recapture. At the close of Year 2, the amount of the qualified 
basis is less than the amount of the qualified basis at the close of 
Year 1, because Unit #4's unsuitability for occupancy prohibits it from 
being a low-income unit. Unit #4's failure to be a low-income unit, 
therefore, reduces the applicable fraction and thus the qualified basis 
as well. This results in a credit recapture amount for Year 2. Under 
paragraph (f)(2) of this section, however, for purposes of calculating 
the recapture amount, Unit #2's status as a removed unit does not 
impair its contribution to the applicable fraction and the qualified 
basis.
    (C) Restoration of habitability and of qualified basis. As 
described in the facts in paragraph (g)(2)(i) of this section, in Year 
4, after repair work is complete, the formerly uninhabitable Unit #4 is 
again suitable for occupancy, and the taxpayer ends the status of Unit 
#2 as a removed unit. Thus, both units are now low-income units, 
neither is a removed unit, and so both are included in the computations 
for the average income test. At the close of Year 4, therefore, the 
average of the imputed income limitations of all of the low-income 
units in the project is 60 percent of AMGI, which is calculated as 
follows: (2 x 40% + 1 x 60% + 2 x 80%)/5 = 60%. For purposes of 
computing the credit under section 42(a) for Year 4, both units are 
included in the applicable fraction and, thus, are included in 
qualified basis for purposes of that calculation. Prior to the 
restoration in Year 4, for purposes of a computation of credits under 
section 42(a), Unit #4 does not contribute to qualified basis because 
it is not a low-income unit, and, under paragraph (f)(3) of this 
section, Unit #2 does not contribute to qualified basis because it is a 
removed unit.
    (h) Applicability dates. This section applies to taxable years 
beginning after [date these regulations are published as final 
regulations in the Federal Register].

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2020-20221 Filed 10-29-20; 8:45 am]
BILLING CODE 4830-01-P