[Federal Register Volume 87, Number 196 (Wednesday, October 12, 2022)]
[Rules and Regulations]
[Pages 61489-61506]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-22070]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9967]
RIN 1545-BO92


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

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations setting 
forth guidance on the average income test for purposes of the low-
income housing credit. If a building is part of a residential rental 
project that satisfies this test, the building may be eligible to earn 
low-income housing credits. These final and temporary regulations 
affect owners of low-income housing projects, tenants in those 
projects, and State or local housing credit agencies that monitor 
compliance with the requirements for low-income housing credits.

DATES: 
    Effective date: These regulations are effective on October 12, 
2022.
    Applicability date: For the applicability date of the temporary 
regulations, see Sec.  1.42-19T(f).

FOR FURTHER INFORMATION CONTACT: Dillon Taylor at (202) 317-4137.

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) under section 42 of the Internal Revenue Code (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 (effectively, a credit rate) 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)). Section 42(c)(1)(B) defines applicable fraction 
as the smaller of the unit fraction or floor space fraction. The unit 
fraction is the number of low-income units in the building over the 
number of residential rental units (whether or not occupied) in the 
building. The floor space fraction is the total floor space of low-
income units in the building over the total floor space of residential 
rental units (whether or not occupied) in the building. Subject to 
certain exceptions set forth in section 42(i)(3)(B), a low-income unit 
is defined in section 42(i)(3) as any unit in a building if the unit is 
rent-restricted and the individuals occupying the unit meet the income 
limitation under section 42(g)(1) that applies to the project of which 
the building is a part. 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 (the period of 15 taxable years 
beginning with the first taxable year of the credit period). 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, known as the 20-50 test and the 40-
60 test. If a taxpayer elects to apply 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). If a taxpayer elects to 
apply 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.
    The 2018 Act added section 42(g)(1)(C), which contains a third 
minimum set-aside test option--the average income test. If a taxpayer 
elects to apply the average income test, a project meets the minimum 
requirements of the average income test if 40 percent or more 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 specific unit. (In the 
case of a project described in section 142(d)(6)), ``40 percent'' in 
the preceding sentence is replaced with 25 percent.) Section 
42(g)(1)(C)(ii)(I)-(III) provides special rules relating to the income 
limitation for the average income test. Specifically, unlike the 20-50 
and 40-60 tests, section 42(g)(1)(C)(ii)(I) requires the taxpayer to 
designate each unit's imputed income limitation that is taken into 
account for purposes of the average income test. Section 
42(g)(1)(C)(ii)(II) requires the average of the imputed income 
limitations designated under section 42(g)(1)(C)(ii)(I) not to exceed 
60 percent of AMGI. Finally, section 42(g)(1)(C)(ii)(III) requires the 
imputed income limitation designated for any unit to be 20, 30, 40, 50, 
60, 70, or 80 percent of AMGI.
    Generally, under section 42(g)(2)(D)(i), if the income for the 
occupant of a low-income unit rises above the relevant income 
limitation, the unit continues to be treated as a low-income unit if 
the income of the occupant had 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 the 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 if two disqualifying conditions occur.
     The first condition is that the occupant's income 
increases above 140 percent of the income limitation applicable 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 
rental 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) of the Code ``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.
    The exception contained in section 42(g)(2)(D)(ii) is referred to 
as the next

[[Page 61490]]

available unit rule. See also Sec.  1.42-15 of the Income Tax 
Regulations.
    The 2018 Act added a new next available unit rule in section 
42(g)(2)(D)(iii), (iv), and (v) for situations in which the taxpayer 
has elected the average income test. Under this new rule, a unit ceases 
to be a low-income unit if two slightly different disqualifying 
conditions are met:
     First, 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; and
     Second, a new occupant whose income exceeds the applicable 
imputed income limitation occupies any other residential rental unit in 
the building that is of a comparable or smaller size. The applicable 
imputed income limitation for this purpose depends upon whether the 
unit being occupied was a low-income unit before becoming vacant.
    [cir] If the new tenant occupies a unit that was taken into account 
as a low-income unit prior to becoming vacant, section 
42(g)(2)(D)(v)(I) provides that the applicable imputed income 
limitation is the limitation designated with respect to the unit.
    [cir] If the new tenant occupies a market-rate unit, section 
42(g)(2)(D)(v)(II) provides that the applicable imputed income 
limitation is ``the imputed income limitation which would have to be 
designated with respect to such unit under [section 42(g)(1)(C)(ii)(I)] 
in order for the project to continue to meet the requirements of 
[section 42(g)(1)(C)(ii)(II)].'' (Those requirements mandate that the 
``average of the imputed income limitations designated under [section 
42(g)(1)(C)(ii)(I)] shall not exceed 60 percent of'' AMGI.)
    Section 42(g)(2)(D)(iv) also provides a next available unit rule 
for deep rent skewed projects that elect the average income test.
    Under section 42(g), once a taxpayer elects to use a particular 
set-aside test for a project, that election is irrevocable. Thus, if a 
taxpayer had previously elected to use the 20-50 test or the 40-60 
test, the taxpayer may not subsequently elect to use the average income 
test. Under section 42(g)(4), the rules of sections 142(d)(2)(B) 
through (E), 142(d)(3) through (7), and 6652(j) of the Code apply to 
determine 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 section 
42(m)(1)(B)(iii), a QAP must contain a procedure that the Agency or its 
agent will follow in monitoring noncompliance with low-income housing 
credit requirements and in notifying the IRS of any such noncompliance. 
See Sec.  1.42-5 of the Income Tax Regulations for rules implementing 
this requirement.
    On October 30, 2020, the Department of Treasury (Treasury 
Department) and the IRS published a notice of proposed rulemaking 
(NPRM) (REG- 119890-18) in the Federal Register (85 FR 68816) proposing 
regulations setting forth guidance on the average income test under 
section 42(g)(1)(C). The Treasury Department and the IRS received 98 
comments, including requests to testify at a public hearing on the 
proposed regulations and written testimony for the public hearing.
    On March 24, 2021, the Treasury Department and the IRS held a 
public hearing on the proposed regulations. Fifteen taxpayers provided 
testimony at the hearing.
    After consideration of the comments received and the testimony 
provided, the proposed regulations are adopted as modified by this 
Treasury Decision. The major areas of comment and the revisions to the 
proposed regulations are discussed in the following Summary of Comments 
and Explanation of Revisions. The comments are available for public 
inspection at www.regulations.gov or upon request. Other minor, non-
substantive modifications that were made to the proposed regulations 
and adopted in these final regulations are not discussed in the Summary 
of Comments and Explanation of Revisions. In addition, the Treasury 
Department and the IRS are publishing in this Treasury Decision 
temporary regulations containing recordkeeping and reporting 
requirements that are needed to facilitate administrability of, and 
compliance with, changes made in the final regulations. Those changes 
were based on comments received on the proposed rule. These 
requirements are described in this preamble along with the substantive 
rules contained in the final regulations. The text of these temporary 
regulations also serves as the text of the proposed regulations (REG-
113068-22) set forth in the notice of proposed rulemaking on this 
subject in the Proposed Rules section of this issue of the Federal 
Register.

Summary of Comments and Explanation of Revisions

    These final regulations and temporary regulations set forth 
guidance on the average income test under section 42(g)(1)(C).

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

    The proposed regulations updated 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). One commentator recommended that no changes be made to the 
proposed regulations concerning the next available unit rule when the 
proposed regulations are finalized. No other comments were received on 
the next available unit rule.
    While no comments requested changes, the final regulations for the 
next available unit rule were revised to be consistent with changes 
made to the provisions in Sec.  1.42-19, which are described in section 
II of this Summary of Comments and Explanation of Revisions. The final 
regulations include revisions to the two limitations in Sec.  1.42-
15(c)(2)(iv) related to the imputed income designation of the next 
available unit, which relate to the limitations described in section 
42(g)(2)(D)(v). The final regulations provide taxpayers with 
administrable rules and objective standards to apply when determining 
the designation of the next available unit. The first limitation in 
Sec.  1.42-15(c)(2)(iv)(A) applies to units that met all of the 
requirements in Sec.  1.42-19(b)(1)(i) through (iii) prior to becoming 
vacant. In other words, the unit was rent-restricted, the occupants 
satisfied the imputed income limitation for the unit (or the unit's 
low-income status continued under section 42(g)(2)(D)), and no other 
provision in section 42 or the regulations thereunder denied low-income 
status to the unit. For those units, which would have had a designated 
imputed income limitation prior to vacancy, the limitation is the 
unit's designated imputed income limitation. This rule is equivalent to 
the rule in the proposed regulations, which interpreted the definition 
of low-income unit as including only the requirements in Sec.  1.42-
19(b)(1)(i) through (iii). The second limitation in Sec.  1.42-
15(c)(2)(iv)(B) requires a taxpayer, in the case of any other unit 
(such as a market rate unit), to limit the imputed income limitation to 
a designation that will not cause the average of all imputed income 
designations of residential units in the

[[Page 61491]]

project to exceed 60 percent of AMGI. This ensures that the next 
available unit is designated in such a way that maintains compliance 
with the averaging requirement in section 42(g)(2)(C)(ii)(II). This 
revision to the second limitation was necessary because the proposed 
regulations relied on a reference to the mitigating action provisions, 
which were removed from the final regulations as explained in section 
II.B. of this Summary of Comments and Explanation of Revisions.
    Additionally, these final regulations provide that, if multiple 
units are over-income at the same time in a project that has elected 
the average income set-aside (average income project) and that has a 
mix of low-income and market-rate units, then the taxpayer need not 
comply with the next available unit rule in a specific order with 
respect to occupancy. Instead, renting any available comparable or 
smaller vacant unit to a qualified tenant maintains all over-income 
units' status 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). The final regulations 
include an example illustrating the application of this rule. Note, the 
order in which units are designated, however, may affect the qualified 
group that is used for computing the applicable fraction. See further 
discussion in section II.B of this Summary of Comments and Explanation 
of Revisions.

II. Sec.  1.42-19, Average Income Test

A. Requirements To Satisfy the Average Income Test

1. Proposed Regulations Approach to the Average Income Test
    The proposed regulations provided that a project for residential 
rental property meets the requirements of the average income test under 
section 42(g)(1)(C) 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 tenants whose income does not exceed the imputed income limitation 
designated by the taxpayer with respect to the respective unit; (2) the 
taxpayer designated the imputed income limitations in the manner 
provided in Sec.  1.42-19(b) of the proposed regulations; and (3) the 
average of the designated imputed income limitations of the low-income 
units in the project does not exceed 60 percent of AMGI. The proposed 
regulations would have required taxpayers to complete, not later than 
the close of the first taxable year of the credit period, the initial 
designation of imputed income limitations for all of the units taken 
into account for the average income test.
    Under the proposed regulations, the 60 percent of AMGI limit on the 
average of designated imputed income limitations applied to all of the 
low-income units in the project. The requirement as so interpreted did 
not take into account whether fewer than all of those units could 
constitute a group of at least 40 percent of the residential units in 
the project such that the average of the limitations of the units in 
that group averaged to no more than 60 percent of AMGI.
    In some cases, this interpretation magnified the adverse 
consequences of a single unit's failure to maintain low-income status. 
For example, under the proposed regulations, a unit losing low-income 
status would remove that unit's imputed income limitation from the 
computation of the average, but not impact the low-income status of any 
other units. If that unit's limitation was less than 60 percent of 
AMGI, the loss of the unit could cause the average of the remaining 
low-income units to rise above 60 percent of AMGI. That noncompliant 
average would cause the entire project to fail the average income test 
and therefore fail to be a qualified low-income housing project. In 
light of the potential adverse consequences of the rule, the proposed 
regulations provided for mitigating actions the taxpayer could take 
within 60 days of the close of the year for which the average income 
test might be violated.
2. Comments on the Proposed Set-Aside Rule
    Many commenters disagreed with the adequacy of the proposed 
mitigation actions and with the correctness of the underlying 
interpretation of the average income test, which required testing of 
all low-income units.
i. Inadequacy of the Proposed Mitigation Actions
    Commenters noted that the mitigation possibilities in the proposed 
regulations depended on the taxpayer both appreciating that the entire 
project might be jeopardized by a problem with a particular unit and 
knowing how to deploy the mitigation actions. Commenters also suggested 
that the mitigation proposal incorporated such a rigid deadline that 
even alert and well-advised taxpayers might be unable to timely take 
mitigating actions to be eligible to receive credits for their 
projects.
ii. Invalidity of the Underlying Interpretation
    Commenters' central concern was the invalidity, as they saw it, of 
the underlying interpretation of the average income test. Under the 
interpretation in the proposed regulations, a single unit's falling out 
of compliance could result in the complete loss of tax credits for the 
entire project, or at least loss of credits for an entire year. 
Commenters noted that this result flowing from the interpretation in 
the proposed regulations suggested the invalidity of the 
interpretation. Several commenters observed that the proposed 
regulations imposed on projects electing the average income test a 
higher standard than that required for satisfying the other set-aside 
elections. Under the 20-50 test and 40-60 test, one noncompliant unit 
could not cause an entire project to fail the set-aside test if, 
without taking the noncompliant unit into account, there remained a 
sufficient number of compliant units to meet the statutory minimum 
percentage of all residential units. The commenters, therefore, 
concluded that the interpretation in the proposed regulations regarding 
the average income test could not have been the intent of Congress.
    Most commenters recommended that the average income test be 
satisfied if any group of 40 percent of the units in the project have 
designations whose average does not exceed 60 percent of AMGI. In 
general, these commenters correctly asserted that the average income 
test is a minimum set-aside test, and, therefore, a project should meet 
the test if the minimum requirements of the test are satisfied, even if 
low-income units not necessary for the minimum are noncompliant.
    Other commenters noted that even though the project should 
additionally meet an overall average test of no more than 60 percent of 
AMGI across all low-income units (as required by the proposed 
regulations), relief should nevertheless be built into the requirement. 
Thus, if a unit is out of compliance, causing the project-wide average 
to go above 60 percent of AMGI, the failure should be considered 
noncompliance for that unit only, and only that non-compliant unit 
should be subject to credit adjustment and recapture. They urged that 
this noncompliance should not be a violation of the minimum set-aside, 
provided that at least 40 percent of the units' designations still meet 
the 60 percent average.
    This suggested approach, however, could create problems similar to 
those in the proposed regulations because one

[[Page 61492]]

unit's noncompliance could cause the overall average of the remaining 
low-income units to rise above 60 percent of AMGI. For this reason, the 
comment was not adopted, but it was considered in connection with 
developing the final regulations' rules for determining low-income 
units and a building's applicable fraction, as is discussed later.
    Some commenters believed that the average income test is satisfied 
as long as the original imputed income limitations of designated low-
income units average to 60 percent, and 40 percent or more of those 
units continue to be rent-restricted and meet their respective imputed 
income limitations. Thus, the average must be met initially, but 
subsequently, the requirement is permanently satisfied, regardless of 
any changes in circumstances related to occupancy. Commenters suggested 
that a general anti-abuse rule could be adopted to allow the IRS to 
disregard designations made in bad faith.
    The Treasury Department and the IRS do not agree that the averaging 
requirement of section 42(g)(1)(C)(ii)(II) is concerned only with the 
original designations. Like the other minimum set-aside tests, the 
average income test is an ongoing requirement for a project to maintain 
its status as a qualified low-income housing project. A project failing 
to maintain an average of 60 percent or less of AMGI across at least 40 
percent of its residential units that qualify as low-income units 
violates the requirement. This is consistent with a plain reading of 
the statute, as the imputed income limitations of the units taken into 
account (meaning, counted for purposes of meeting the average income 
test) must not exceed 60 percent of AMGI. Section 42(g)(1)(C)(ii)(I) 
and (II). The rejected suggestion would allow an original imputed 
income limit designation of a subsequently disqualified unit to satisfy 
compliance with the minimum set-aside test throughout the entire 
compliance period. Treating such a situation as compliant would 
effectively waive the rule that a project consistently maintain its 
level of affordability--a central requirement of the low-income housing 
credit. Moreover, adoption of a general anti-abuse rule would miss many 
non-compliant situations, would increase administrative complexity for 
the IRS and the Agencies and would potentially create uncertainty for 
taxpayers.
    A separate comment recommended that an out-of-compliance unit 
should maintain its designation if the owner can demonstrate due 
diligence when completing the initial income certification. The 
Treasury Department and IRS disagree with the suggestion that an out-
of-compliance unit should not lose its designation if the owner can 
demonstrate due diligence when completing the initial income 
certification. Demonstrating due diligence upon initial income 
certification is not sufficient to satisfy ongoing compliance 
requirements. Further, similar to a general anti-abuse rule proposed by 
another commenter, this approach would increase administrative 
complexity for the IRS and Agencies and could potentially create 
uncertainty for taxpayers.
3. The Final Regulations' Interpretation of the Average Income Test
    In response to the comments received, the Treasury Department and 
the IRS have revised their interpretation of the set-aside rule and 
incorporated the revised interpretation in the final regulations. In 
making these revisions, the Treasury Department and the IRS considered 
the plain language of section 42(g)(1)(C) as well as the definition of 
low-income unit for projects electing the average income test. When 
section 42(g)(1)(C)(i) and the special rules in section 
42(g)(1)(C)(ii)(I) and (II) are read together, the taxpayer satisfies 
the average income test if at least 40 percent of the building's 
residential units are eligible to be low-income units and have 
designated imputed income limitations that collectively average 60 
percent or less of AMGI. A project satisfying this minimum requirement 
satisfies the average income test. Thus, the final regulations have 
been revised so that it is no longer necessary to consider all low-
income units in a project for residential rental property when 
determining whether the average income test is met.
    While making this change, the Treasury Department and the IRS also 
considered the definition of ``low-income unit'' in a project electing 
the average income test, and the final regulations provide a clarifying 
definition of this term. As the final regulations no longer require a 
taxpayer to consider all of the low-income units in a project in order 
to satisfy the minimum set-aside requirement, the issue for 
consideration is whether a project's election of the average income 
test has any impact on whether a unit that is rent-restricted and whose 
occupants satisfy the imputed income limitation designated for the unit 
qualifies as a low-income unit as that term is defined in section 
42(i)(3). This determination is relevant for the average income test as 
well as for purposes of the other provisions of the low-income housing 
credit, including a building's applicable fraction as explained later.
    In defining the term ``low-income unit,'' section 42(i)(3)(A)(ii) 
requires that the individuals occupying the unit meet the income 
limitation applicable under section 42(g)(1) to the project of which 
the building is a part. With respect to the 20-50 and the 40-60 minimum 
set-asides, there is no difficulty in applying this language to 
specific units. Every unit in the project has an identical income 
limitation, namely the income limitation embodied in the set-aside test 
that the taxpayer elected for that project. If the taxpayer elects the 
20-50 test, then the income limitation for each unit is 50% of AMGI. If 
the taxpayer elects the 40-60 test, the income limitation for each unit 
is 60% of AMGI.
    For a project electing the average income test, however, the 
reference to ``the income limitation applicable . . . to the project'' 
poses a challenge because income limitations will typically vary among 
the units in the project. In addition, pursuant to section 
42(g)(1)(C)(ii)(II), the average of the designated imputed income 
limitations for the units taken into account for meeting the minimum 
set-side test must not exceed 60% of AMGI. As a result, for purposes of 
the average income test, the fact that the occupants of a unit satisfy 
the imputed income limitation designated for that unit does not by 
itself establish that the unit satisfies the requirements in section 
42(i)(3)(A).
    The Treasury Department and the IRS considered interpreting the 
language in section 42(i)(3)(A)(ii) as referring only to the income 
limitation designated for a specific unit. Such an interpretation would 
be consistent with the approach under the 20-50 and 40-60 tests where a 
single unit's noncompliance does not impact the low-income status of 
any other low-income units in the project. It would also be in accord 
with many comments that argue the low-income status of one unit should 
not impact the status of other units if those other units meet their 
respective income limitations.
    In a project electing the average income test, however, it is 
insufficient to read ``the income limitation applicable under [section 
42(g)(1)] to the project'' as referring only to the designated imputed 
income limitation appliable to a unit. Under the average income test, a 
unit's status as a low-income unit for purposes of the set-aside and 
the applicable fraction depends not only on its own attributes but also 
on the income limitations of other units that are taken into account 
for these purposes. In contrast, under the historic set-asides, knowing 
that a unit satisfies the income limitation

[[Page 61493]]

applicable to the unit is sufficient to know that the unit meets the 
project's income limitation for purposes of the minimum set-aside test 
and a building's applicable fraction.
    This interpretation means that to qualify as a low-income unit in a 
project electing the average income test, a residential unit, in 
addition to meeting the other requirements to be a low-income unit 
under section 42(i)(3), must be part of a group of units such that the 
average of the imputed income limitations of the units in the group 
does not exceed 60 percent of AMGI. Thus, to provide clarity on the 
definition of low-income unit for a project electing the average income 
test, the final regulations include a definition of low-income unit 
that takes into account whether the unit is a member of a group of 
units with a compliant average limitation.
    This definition of low-income unit in the final regulations is in 
accord with the definition of low-income unit as originally described 
in the Conference Report for the Tax Reform Act of 1986 (1986 
Conference Report):

    A low-income unit includes any unit in a qualified low-income 
building if the individuals occupying such unit meet the income 
limitation elected for the project for purposes of the minimum set-
aside requirement and if the unit meets the gross rent requirement, 
as well as all other requirements applicable to units satisfying the 
minimum set-aside requirement.

2 H.R. Conf. Rep. 99-841, 99th Cong., 2d Sess., II-94-95.

    In that explanation, it is required that a low-income unit meet 
``all other requirements applicable to units satisfying the minimum 
set-aside test.'' Although the average income test was not in existence 
at the time of the 1986 Conference Report, it is apparent that Congress 
wanted to avoid creating one standard for low-income units that 
qualified their projects as part of the 20-50 and 40-60 minimum set-
asides and a different standard for any other low-income units that 
played some other role in the same project. Thus, it is consistent with 
how low-income units are defined under the 20-50 and 40-60 minimum set-
aside tests for these final regulations to require all low-income units 
in an average income project to satisfy a consistent and equal set of 
standards--standards that, in the average income context, incorporate 
the average income limitations of the group of which the units are a 
part.
    Accordingly, under the final regulations, a project for residential 
rental property meets the requirements of the average income test if 
the taxpayer's project contains a qualified group of units that 
constitutes 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. Section 1.42-19(b)(2)(i) requires the units in a qualified 
group to, first, individually satisfy the criteria that would qualify 
each unit as a low-income unit under the 20-50 or 40-60 set-asides. 
Specifically, the rules in Sec.  1.42-19(b)(1)(i) through (iii) require 
that each unit be rent-restricted, occupants of the unit meet the 
income limitation for the unit, and no other provision in section 42 or 
the regulations thereunder denies low-income status to the unit 
(including section 42(i)(3)(B)-(E)). In addition, Sec.  1.42-
19(b)(2)(ii) requires that the average of the designated imputed income 
limitations of the units in the group not exceed 60 percent of AMGI. 
The group of units must be identified as required in Sec.  1.42-
19(b)(3)(i). A taxpayer identifies the units in the group by recording 
the units in the taxpayer's books and records, and the taxpayer must 
communicate that annual identification to the applicable Agency as 
required in Sec. Sec.  1.42-19(b)(3)(iii) and 1.42-19T(c)(1) of the 
associated temporary regulations. See further description in section 
II.C of this Summary of Comments and Explanation of Revisions.
    These revisions provide more flexibility for meeting the average 
income test than had been available under the proposed regulations. 
Most importantly, the revised rules limit the impact of one unit's 
noncompliance on the ability of a project to satisfy the average income 
test. The status of additional units beyond the minimum number of units 
needed to satisfy the test does not impair satisfaction of the average 
income test as discussed in section II.B of this Summary of Comments 
and Explanation of Revisions. By removing the proposed requirement 
applicable to all low-income units and thus allowing a project to 
satisfy the average income test if it contains a qualified group of 
units meeting the minimum requirements, the final regulations generally 
avoid the outsized impact that one unit's loss of low-income status 
could have under the proposed regulations. The interpretation of the 
average income set-aside in the final regulations is consistent with 
the majority of comments on this issue.
    In addition, this interpretation creates more parallels between the 
average income test and the 20-50 and 40-60 tests. Under either of 
those latter tests, when there are more than the minimum number of low-
income units, one unit going out of compliance would not cause a 
project to fail the minimum set-aside test. Similarly, under the final 
regulations, one unit's loss of low-income status will not jeopardize 
the entire project's status as a qualified low-income housing project 
subject to the average income test if there are a sufficient number of 
remaining units that comprise a qualified group of units that satisfy 
the minimum set-aside.

B. Determining Qualified Groups of Units for Use in Applicable Fraction 
Determinations

1. Role of the Applicable Fraction Under Section 42
    As mentioned earlier, the amount of low-income housing credits 
earned by a building in a taxable year depends on a computation that 
includes a number called the building's ``applicable fraction'' for 
that year. This fraction is based on the number and size of the low-
income and non-low-income units in the building and can be thought of 
as an indicator of the extent to which the building is dedicated to 
affordable housing. Thus, the applicable fraction plays a role both in 
determining credits during the credit period and in demonstrating 
continued dedication to affordable housing during the extended use 
period. See section 42(h)(6)(B)(i).
2. The Proposed Regulations' Resolution of Issues Posed by Computation 
of the Applicable Fraction in an Average Income Project
    The proposed regulations provided an approach to addressing 
continuous compliance with the average income requirement by using the 
same group of low-income units for both satisfying the minimum set-
aside requirement and determining the applicable fraction. The proposed 
regulations also provided for a removed unit, which was a low-income 
unit identified by the taxpayer that was not taken into account for 
purposes of the set-aside test or the applicable fraction but was taken 
into account for purposes of reducing recapture. As described earlier 
in this Summary of Comments and Explanation of Revisions, taxpayers 
strongly criticized the set-aside rule. In response, the final 
regulations both allow the minimum set-aside test to be satisfied by 
any qualified group of units that is no smaller than the statutory 
minimum (40 percent) and also add a clarifying definition of ``low-
income unit'' for projects electing the average income test. To 
implement the statutory requirement regarding the average of the 
imputed income limitations of residential units in a project, this 
clarifying definition is sensitive to the

[[Page 61494]]

imputed income limitations of the other residential units in the same 
group.
    The approach in the final regulations for the average income test 
differs from the other two set-asides in that the final regulations 
allow for a distinction between the group of low-income units taken 
into account for satisfying the minimum set-aside and the (usually 
larger) group of units taken into account for computing credits. 
However, under the final regulations, the units included in both groups 
are subject to the same standards.
    Congress acknowledged the absence of such a distinction in the 20-
50 and 40-60 tests in its discussion of the low-income housing credit 
in the 1986 Conference Report:

    Qualified residential rental projects must remain as rental 
property and must satisfy the minimum set-aside requirement, 
described above, throughout a prescribed compliance period. Low-
income units comprising the qualified basis on which additional 
credits are based are required to comply continuously with all 
requirements in the same manner as units satisfying the minimum set-
aside requirements. Units in addition to those meeting the minimum 
set-aside requirement on which a credit is allowable also must 
continuously comply with the income requirement.

2 H.R. Conf. Rep. 99-841, 99th Cong., 2d Sess., II-95.

    Thus, under the 20-50 and 40-60 tests, units included in qualified 
basis in addition to those needed to satisfy the minimum set-aside must 
meet the same requirements as the units used to satisfy the minimum 
set-aside. This application under the 20-50 and 40-60 tests is 
straightforward, however, because all low-income units have to be at or 
less than a single elected AMGI standard, either 50 percent or 60 
percent of AMGI (assuming other requirements are met). Under either 
test, the minimum set-aside units and any additional low-income units 
are effectively interchangeable, so there was no need to clarify 
treatment between the groups.
    For the average income test, however, units are not interchangeable 
because they have a range of imputed income limitations and cannot be 
evaluated in isolation because there is an income averaging requirement 
in section 42(g)(1)(C)(ii)(II). By stating that additional units beyond 
those meeting the minimum set-aside test must continuously comply with 
the income requirement, the 1986 Conference Report identified the 
necessity of developing a common standard for all residential units in 
projects electing the 20-50 and 40-60 tests. As discussed in section 
II.A.3 of this Summary of Comments and Explanation of Revisions, this 
principle is reflected in the final regulations' definition of low-
income units, and it impacts the treatment of units that may be taken 
into account for computing a building's applicable fraction.
3. Comments on Determining the Applicable Fraction
    In the context of the 20-50 or 40-60 minimum set-asides, commenters 
noted, non-compliance by one or more units (for example, not being 
suitable for occupancy) reduces a building's applicable fraction only 
with respect to the units that are non-compliant as of the taxpayer's 
year end. These commenters recommended similar treatment in the average 
income context. They advocated evaluating eligibility of units for 
inclusion in the applicable fraction on a unit-by-unit basis (that is, 
taking into account only facts about the particular unit, without 
taking into account the designated imputed income limitation of other 
units).
    In the context of removed units, some comments argued that the 
proposed applicable fraction treatment of these units amounted to 
``double counting.'' Not only did the proposed regulations exclude the 
noncompliant unit from the computation of the applicable fraction of 
the building containing the unit, but by taking into account the 
average of the group's income limitations, they could force a taxpayer 
to exclude one or more compliant units from the applicable fraction(s) 
of the building(s) containing the compliant unit(s).
    The Treasury Department and the IRS considered the proposal to 
include units in applicable fraction computations on a unit-by-unit 
basis but did not adopt it. To be sure, that proposal would preserve 
the requirement that units satisfying the set-aside requirement must 
have income limitations whose average does not exceed 60 percent of 
AMGI. The proposal, however, would not apply this average requirement 
to the units that are taken into account for the project's applicable 
fractions. The proposed approach would thus be inconsistent with the 
language of section 42(c)(1)(c)(i), which provides that the numerator 
of the applicable fraction is number of ``low-income units'' in the 
building. As explained earlier in the discussion of the average income 
test, the definition of low-income unit for a project electing the 
average income test necessarily includes the requirement that the 
average of the designated income limitations of the units taken into 
account as low-income units includes that the average designated income 
limitations of the units not exceed 60% of AMGI.
    In addition, the failure to apply the average income limitation in 
determining the applicable fraction would allow a taxpayer to include 
units in the qualified basis even if they are a majority of the units 
in a project and their average limitation greatly exceeds 60 percent of 
AMGI. If accepted, the proposal would have allowed a taxpayer to give 
appropriate income limitations to 40 percent of a project's units but 
to designate limitations of 80 percent of AMGI for all the remaining 
low-income units in the project and receive credits for all of these 
units.
    In the context of determining what units to include in the 
applicable fraction, another commenter recommended revising the 
proposed regulations to include an exception for units that are not 
habitable due to a casualty loss, such as from a fire in the unit. The 
commenter asserted that because the noncompliance was not the fault of 
taxpayer, the regulations should not require the taxpayer to remove 
another unit from an applicable fraction to offset the noncompliance 
associated with the casualty loss. The Treasury Department and the IRS 
did not adopt this suggestion. An approach that requires a 
determination of fault would create additional complexity for 
taxpayers, Agencies, and the IRS. In addition, while the 20-50 and 40-
60 set-asides do not have the same issue, adopting rules allowing for 
special treatment in the case of casualties would necessitate a broader 
section 42 regulatory project.
4. Determination of the Applicable Fraction in the Final Regulations
    Under the final regulations, the determination of a group of units 
to be taken into account in the applicable fractions for the buildings 
in a project follows the same approach as determining a group of units 
to be taken into account for purposes of the set-aside test. 
Essentially, a taxpayer can determine this group of units by including 
the low-income units identified for the average income test, and any 
other residential units that can qualify as low-income units if they 
are part of a group of units such that the average of the imputed 
income limitations of all of the units in the group does not exceed 60 
percent of AMGI. If the average exceeds 60 percent of AMGI, then the 
group is not a qualified group. For example, if a unit was designated 
at 80 percent of AMGI and if including that unit in an otherwise 
qualified group of units causes the average of the imputed

[[Page 61495]]

income limitations of the group to exceed 60 percent of AMGI, then the 
taxpayer cannot include the 80 percent unit in the otherwise qualified 
group. Only the otherwise qualified group of units, without the 80 
percent unit, is a qualified group of units used to determine the 
project's buildings' applicable fractions.
    Once a qualified group of units in a project has been identified 
for a taxable year, the applicable fraction for each building in the 
project is computed using the units that are in both the qualified 
group and the building at issue. (Although the qualified group of units 
for a project must have an average limitation no greater than 60 
percent of AMGI, this is not true of the average limitation of the 
units used to compute the applicable fraction of individual buildings 
in the project.) This method of determining a building's applicable 
fraction applies both for ascertaining low-income housing credits 
earned for a year in the credit period and for complying with the 
extended use requirement in section 42(h)(6)(B)(i).
    The Treasury Department and the IRS determined that the approach to 
determining the applicable fraction in the final regulations better 
aligns with the 20-50 and 40-60 set-aside tests than the approach in 
the proposed regulations in that it creates parallel requirements for 
both ``minimum set-aside units'' and any ``additional units'' that may 
contribute to earning low-income housing credits. This rule in the 
final regulations is also consistent with the description of the low-
income units and the principle regarding set-aside units and additional 
units in the other set-aside tests that is described in the 1986 
Conference Report discussion quoted earlier. The rule is also 
consistent with comments stating that the low-income units in a project 
should have an overall average that does not exceed 60 percent of AMGI.
    The potential downside of this approach to an owner is that if one 
unit loses low-income status, then it is possible that other units' 
status as low-income units may be impacted. Specifically, an owner may 
have to exclude one or more otherwise qualifying units from the 
qualified group of units for use in applicable fraction determinations 
for the group to retain an average income limitation that does not 
exceed 60% of AMGI. This, however, will not always be the case. For 
example, if a unit designated at 60, 70, or 80 percent of AMGI loses 
low-income status and no other changes occurred, then the owner could 
maintain the required average limitation of the qualified group of 
units without excluding any of the other units from the qualified group 
of units that had been taken into account in the previous year. Also, 
as is discussed later, in some cases a unit may be included in the 
qualified group of units after its income limitation has been 
designated or redesignated to a lower income limitation.
5. Proposed Regulations' Special Rule for Determining the Applicable 
Fraction for Purposes of Recapture
    The proposed regulations, in some cases, would have caused a 
compliant low-income unit with a relatively high-income limitation not 
to have been taken into account in computing low-income housing credits 
earned for a year in the credit period. The mechanisms for achieving 
this result were called ``mitigating actions'' and ``removed units''. 
To minimize recapture, the proposed regulations would have included 
these units in the computations underlying section 42(j) so that the 
units' inclusion avoided having their absence contribute to recapture 
of credits. As described in section II.B.6. of this Summary of Comments 
and Explanation of Revisions, however, the Treasury Department and the 
IRS deleted the mitigating actions concept from the final regulations. 
For this reason, the final regulations do not include the proposed 
regulations' rule related to recapture.
6. Deletion of Mitigating Actions From Final Regulations
    As described previously, the proposed regulations would have 
created a risk that, in some situations, one unit losing its low-income 
status could have caused an entire project to fail the average income 
test. To reduce that risk, the proposed regulations described two 
possible mitigating actions that a taxpayer could have taken to avoid 
disqualifying the project. Because the final regulations differ from 
the proposed regulations in a way that avoids that risk, there is no 
longer a need for mitigating actions. For this reason, the final 
regulations do not include rules related to mitigating actions.

C. Recordkeeping and Reporting Requirements

    In response to comments on the proposed rule, the final rule 
provides significant flexibility regarding the qualified group of units 
used to satisfy the average income set-aside and the qualified group of 
units used for purposes of computing the applicable fraction. Providing 
the requested flexibility necessitates that the taxpayer have the 
discretion and responsibility to make these identifications and that 
the contemporary identification of the units be unambiguous.
    Specifically, to implement the changes made in response to the 
comments on the proposal rule, Sec.  1.42-19(b)(3) of the final 
regulations provides that a taxpayer separately identifies (i) units in 
the qualified group of units used for satisfying the average income 
set-aside and (ii) units in the qualified group for purposes of the 
applicable fractions. Section 1.42-19T(c)(1) of the temporary 
regulations requires that this be done by recording these 
identifications in the taxpayer's books and records (where the 
identification must be retained for a period not shorter than the 
record retention requirement under Sec.  1.42-5(b)(2)) and by 
communicating that identification annually to the applicable Agency. 
These rules promote certainty and administrability. The rules, in 
conjunction with the other procedures provided in Sec.  1.42-19T(c)(3), 
will allow taxpayers, Agencies, and the IRS to more easily verify the 
status, including the average imputed income limitation, of the 
qualified group of units used for purposes of satisfying the average 
income set-aside and the qualified group of units used for purposes of 
determining the applicable fraction(s).
    In addition, taxpayers are required to report specified information 
to Agencies and to maintain records in sufficient detail to establish 
the accuracy of the project's applicable fractions, the satisfaction of 
the average income set-aside, and compliance with requirements in 
section 42 and the applicable regulations. Section 1.6001-1 requires 
the keeping of records ``sufficient to establish the amount of gross 
income, deductions, credits, or other matters required to be shown by 
such person in any return of such tax or information.'' See Sec. Sec.  
1.6001-1 and 1.42-5.

D. Designation of Imputed Income Limitations and Identification of 
Units

    Section 42(g)(1)(C)(ii) contains substantive requirements for 
income limitations applicable in the average income test. Specifically, 
the taxpayer must designate the imputed income limitation for each unit 
taken into account under the average income test; the average of those 
imputed income limitations cannot exceed 60 percent of AMGI; and the 
designated imputed income limitation of any unit must be 20, 30, 40, 
50, 60, 70, or 80 percent of AMGI. That statutory provision, however, 
does not contain procedural requirements to specify the manner in

[[Page 61496]]

which taxpayers must designate the imputed income limitation of units.
    Filling this gap, the proposed regulations added procedural 
requirements that a taxpayer must designate each imputed income 
limitation in accordance with: (1) any procedures established by the 
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); 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 IRS guidance and the governing regulations.
    No negative comments were submitted regarding these provisions, 
but, on review, and in conjunction with other revisions made based on 
comments received, the Treasury Department and the IRS determined that 
more detailed designation rules were needed to promote certainty and 
administrability. Section 1.42-19T(c)(3)(iv) of the temporary 
regulations provides that a taxpayer designates a unit's imputed income 
limitation by recording the limitation in its books and records, where 
it must be retained for a period not shorter than the record retention 
requirement under Sec.  1.42-5(b)(2). The final regulations require the 
initial designation of a unit to be made no later than when a unit is 
first occupied as a low-income unit. See Sec.  1.42-19(c)(3)(i). Under 
Sec.  1.42-19T(c)(3)(iv) of the temporary regulations, the designation 
must also be communicated annually to the applicable Agency, and the 
applicable Agency may establish the time and manner in which 
information is provided to it. See Sec.  1.42-19T(c)(2)(i).
    In the context of the final regulations' provision of significant 
flexibility with respect to satisfying the average income test and 
identifying a qualified group of units, these designation and 
identification rules will facilitate taxpayer access to this additional 
flexibility. Providing a specific method of designation will give 
taxpayers more certainty than the proposed regulations as to how to 
meet the statutory requirement of designation. The rule will also 
benefit administration by ensuring a contemporaneous record of 
designation, without creating a significant burden on taxpayers. The 
final regulations also revise timing of the designation so that it is 
no longer required by the end of the first year of the credit period, 
and instead is based on when a unit is first occupied as a low-income 
unit. This rule better aligns the timing of designation with the rental 
of low-income units and should allow a taxpayer to make designations 
after having a chance to evaluate the market for a particular unit. 
Finally, requiring annual communication of the information to the 
applicable Agency will help the Agency determine whether a project is 
in compliance with the requirements of section 42. The temporary 
regulations give flexibility to Agencies to determine the best time and 
manner for taxpayers to communicate the information so each Agency can 
ensure the system best serves that particular Agency with minimal 
burden.
    Importantly, the temporary regulations also provide Agencies with 
the discretion, on a case-by-case basis, to waive in writing any 
failure to comply with the temporary regulations' recordkeeping and 
reporting requirements. See Sec.  1.42-19T(c)(4). The waiver may be 
done up to 180 days after discovery of the failure, whether by taxpayer 
or Agency. At the discretion of the applicable Agency, this waiver may 
treat the relevant requirements as having been satisfied.
    In providing Agencies with the ability to waive and the timeline 
for waiving, the Treasury Department and the IRS considered comments 
made in response to the proposed regulations regarding the rules for 
``removed units'' and the timing for completing ``mitigating actions.'' 
In response to the proposed regulations' rules on removed units, 
Agencies commented that they do not have authority to determine the tax 
consequences of noncompliance with respect to the requirements of 
section 42, and, instead, Agencies are only responsible for determining 
the existence of noncompliance itself. The ability of Agencies to waive 
the failure to comply with the procedural requirements provided by the 
final regulations is not inconsistent with the scope of Agency 
responsibility, and the IRS itself will ultimately determine the tax 
consequences of noncompliance.
    With respect to timing, many commenters suggested that a 60-day 
period in which to take mitigating actions beginning on the first day 
after the year of noncompliance was too short and began before the 
noncompliance may be known. Commenters recommended various time 
periods, and also suggested that the time period run from the time of 
discovery of the noncompliance. Although the Agency waiver rule in the 
temporary regulations involves a different situation, commenters' 
recommendations provide valuable information regarding Agencies' need 
for a sufficient period of time to consider whether to grant the waiver 
and that this time period should begin when the failure to comply is 
discovered. Thus, the temporary regulations provide that the period to 
provide a waiver is the 180-day period after discovery of the failure 
to comply by taxpayer or Agency.

E. Timing of Designation of Income Limitations

    One commenter expressed concern that, in some situations, a 
multiple-building project claims the section 42 credit beginning in two 
different years depending on when the different buildings in the 
project are fully leased, and thus, the credit period for one building 
in the project may begin in one taxable year and the credit period for 
a second building in the same project may begin during the subsequent 
taxable year. In such a situation, the commenter requested, the 
regulations should permit the taxpayer to make unit designations at the 
end of the respective taxable years in which the credit period begins 
for each building in the same project.
    The final regulations require a designation of the imputed income 
limitation for a unit by the time the unit is first occupied as a low-
income unit, which could take place in different taxable years for 
different units. This rule also allows conversion of a market-rate unit 
to low-income status, with designation of an income limitation 
occurring any time before it is first occupied as a low-income unit. 
Thus, the final regulations provide the flexibility that may be needed 
by multiple-building projects. In addition, as described later, the 
final regulations permit the changing of a unit's imputed income 
limitation in certain circumstances. For an unoccupied unit that is 
subject to a change in imputed income limitation, the final regulations 
provide that the taxpayer must designate the unit's changed imputed 
income limitation prior to occupancy of that unit. For an occupied unit 
that is subject to a change in imputed income limitation, the taxpayer 
must designate the unit's changed imputed income limitation prior to 
the end of the taxable year in which the change occurs.

F. Changing a Unit's Imputed Income Designation

1. The Proposed Regulations on Changes to Income Designations
    In general, the proposed regulations did not allow income 
limitations to be changed after they had been designated.
    The preamble to the proposed regulations, however, requested 
comments on an alternative mitigating approach for situations in which 
a unit

[[Page 61497]]

losing status as a low-income unit had caused the average of unit 
limitations to rise above 60 percent of AMGI as of the close of a 
taxable year. The mitigating approach would have allowed the taxpayer 
to redesignate the imputed income limitation of a low-income unit to 
return the average of unit limitations to 60 percent of AMGI or lower.
2. Comments Seeking Ability To Change Designations
    Numerous commenters disagreed with the proposed regulations' 
disallowance of modifying the designated imputed income limitation of a 
unit. In general, these commenters stressed that greater flexibility to 
change unit designations would align with what multiple Agencies had 
been pursuing to implement existing State and local policies. Some 
commentators observed that the proposed regulations may conflict with 
other Federal or State laws or programs that, in certain cases, require 
rental housing to accommodate a tenant's need to move to another unit. 
Additionally, some commentators noted that after enactment of section 
42(g)(1)(C), some Agencies adopted their own guidance with which the 
subsequently published proposed regulations were in conflict.
    Multiple commenters recommended that the final regulations allow 
taxpayers to modify unit designations if the Agency with jurisdiction 
over the project at issue allows for that in its policies and the 
Agency consents to the change. A different commenter suggested that the 
final regulations should allow taxpayers to adjust imputed income 
limitation designations over time, provided that the taxpayer's 
adjusted designations continue to satisfy the requirements of the 
average income test (that is, at all times 40 percent of the units 
remain rent-restricted and occupied by tenants whose income does not 
exceed the imputed income limitation designated by the owner, and the 
average of the imputed income limitation designations does not exceed 
60 percent of AMGI in any given year).
3. Final Regulations on Changing Designations of Income Limitations
    The Treasury Department and the IRS agree with taxpayers that the 
final regulations should allow greater flexibility in changes in unit 
designations than the proposed regulations did. Because not all 
Agencies may want the exact same standards for permitting 
redesignations, the final regulations address these taxpayer concerns 
by providing Agencies significant flexibility in determining 
procedures.
    Under the final regulations, a taxpayer may change the imputed 
income limitation designation of a previously designated low-income 
unit in any of the following circumstances:
    (1) In accordance with any procedures established by the IRS in 
forms, instructions, or guidance published in the Internal Revenue 
Bulletin pursuant to Sec.  601.601(d)(2)(ii)(b) of this chapter.
    (2) In accordance with an Agency's publicly available written 
procedures, if those procedures are available to all of the Agency's 
projects that have elected the average income test.
    (3) To enhance protections set forth in the Americans With 
Disabilities Act of 1990 (ADA), Public Law 101-336, 104 Stat. 328; the 
Fair Housing Amendments Act of 1988, Public Law 100-430, 102 Stat. 
1619; the Violence Against Women Act of 1994, Public Law 103-322, 108 
Stat. 1902; the Rehabilitation Act of 1973, Public Law 93-112, 87 Stat. 
394; or any other State, Federal, or local law or program that protects 
tenants and that is identified by the IRS or an Agency in a manner 
described in (1) or (2) above. The tenant protections that apply to an 
average-income project and that redesignation may enhance do not 
necessarily have any specific connection to section 42. For example, 
the protections may be ones that apply to all multifamily rental 
housing, or they may apply to the project at issue because some 
congressionally authorized spending supported the project with Federal 
financial assistance. Even if a tenant protection does not legally 
apply to a particular average-income project but does apply to 
analogous multifamily rental housing, the owner of the project may 
redesignate income limitations to implement the protection for the 
project's residents.
    (4) To enable a current income-qualified tenant to move to a 
different unit within a project keeping the same income limitation (and 
thus the same maximum gross rent), with the newly occupied unit and the 
vacated unit exchanging income limitations.
    (5) To restore the required average income limitation for purposes 
of identifying a qualified group of units either for purposes of 
satisfying the average income set-aside or for purposes of identifying 
the units to be used in computing applicable fraction(s). This rule is 
limited to newly designated, or redesignated, units that are vacant or 
are occupied by a tenant that would satisfy the new, lower imputed 
income limitation.
    Also, the temporary regulations provide that a taxpayer effects a 
change in a unit's imputed income limitation by recording the 
limitation in its books and records, where it must be retained for a 
period not shorter than the record retention requirement under Sec.  
1.42-5(b)(2). See Sec.  1.42-19T(d)(2). The new designation must also 
be communicated to the applicable Agency in the time and manner 
required by the applicable Agency and must become part of the annual 
report to the Agency of income designations. As part of its discretion 
to specify the manner of communicating the new designation, the Agency 
may, if it wishes, require identification of the justification for the 
redesignation. The prior designation must be retained in the books and 
records for the period specified in Sec.  1.42-19T(c)(3)(iv). These 
requirements for redesignations are consistent with those for initial 
designation of a unit's imputed income limitation and, similarly, are 
intended to increase both certainty and administrability with respect 
to redesignations.

G. Applicability Dates

    Three commenters recommended that the final regulations should 
provide relief for projects that have elected the average income 
minimum set-aside prior to the publication of the final rule. These 
commenters suggested that taxpayers that elected the average income 
test before the finalization of the regulations did so based on a set 
of expectations that may be in conflict with how the final regulations 
actually work. For example, one commenter stated that the final 
regulations should provide taxpayers the opportunity to choose a 
different minimum set-aside.
    Section 42 provides that an election of a minimum set-aside is 
irrevocable. Therefore, these final regulations do not permit taxpayers 
to change a minimum set-aside election.
    In general, the final regulations apply to taxable years beginning 
after December 31, 2022. Section 1.42-19(f)(2) provides rules for 
residential units in projects that were already occupied prior to the 
applicability date of the regulations. The final regulations in both 
Sec. Sec.  1.42-15(i)(2) and 1.42-19(f)(3) also contain provisions that 
makes them more broadly available for taxpayers that desire their 
application. For taxable years prior to the first taxable year to which 
these regulations apply, taxpayers may rely on a reasonable 
interpretation of the statute in implementing the average income test 
for taxable years to which these regulations do not apply.

H. Good Cause

    For the reasons discussed above, the Treasury Department and the 
IRS consider the recordkeeping and

[[Page 61498]]

reporting requirements contained in the temporary regulations to be a 
logical outgrowth of the proposed rule. In any event, the Treasury 
Department and the IRS determine that there would be good cause to 
issue the temporary regulations contained in this Treasury Decision 
without additional notice and the opportunity for public comment. This 
action may be taken pursuant to section 553(b)(3)(B) of the 
Administrative Procedure Act, which provides that advance notice and 
the opportunity for public comment are not required with respect to a 
rulemaking when an ``agency for good cause finds (and incorporates the 
finding and a brief statement of reasons therefor in the rules issued) 
that notice and public procedure thereon are impracticable, 
unnecessary, or contrary to the public interest.'' Under the ``public 
interest'' prong of 5 U.S.C. 553(b)(3)(B), the good cause exception 
appropriately applies where notice-and-comment would harm, defeat, or 
frustrate the public interest, rather than serving it.
    It would frustrate the public interest to delay the applicability 
date of the regulations until the recordkeeping and reporting 
requirements have received additional notice and comment. Taxpayers are 
seeking to rely on the substantive final regulations as soon as 
possible, and taxpayers cannot do so prior to the applicability date of 
the requirements in the temporary regulations. In general, these 
substantive final regulations provide significant flexibility with 
respect to satisfying the average income test, identifying a qualified 
group of units for use in the average income set-aside test and 
applicable fraction determinations, and changing the imputed income 
limitation designations of residential units. This increased 
flexibility was in response to taxpayer comments on the proposed 
regulations, including taxpayer complaints about burdens in the 
proposed regulations. The increased regulatory flexibility, in turn, 
necessitates these recordkeeping and reporting requirements to enhance 
administrability and certainty for the taxpayers and Agencies that will 
be taking advantage of the flexibility. In addition, these requirements 
are minimally burdensome. The recordkeeping requirements are similar to 
existing recordkeeping requirements for low-income housing projects, 
and Agencies may specify the time and manner of communication of 
regulatorily required information and may waive any failure to comply.
    There is also good cause to find notice is ``unnecessary'' within 
the meaning of 5 U.S.C. 553(b)(3)(B). The Treasury Department and the 
IRS are responding to commenters by providing the flexibility they 
sought, which requires enhanced tracking to prevent abuse. The 
recordkeeping additions do not alter the substance of the basic rule 
provisions, which are a logical outgrowth of the NPRM. And because the 
recordkeeping requirements provide what is minimally necessary to 
ensure compliance and oversight, soliciting further comment would not 
alter these minimal recordkeeping requirements.
    Accordingly, the Treasury Department and IRS have determined that 
notice is unnecessary and that it is in the public interest to allow 
expedited reliance on the recordkeeping and reporting requirements 
contained in the temporary regulations. At the same time, as set forth 
above, the Treasury Department and IRS are soliciting comments on the 
recordkeeping and reporting requirements in the notice of proposed 
rulemaking published contemporaneously with this final rule. At the 
time of publication, the Office of Management and Budget (OMB) has 
considered and approved these recordkeeping and reporting requirements 
under the Paperwork Reduction Act so that taxpayers can rapidly access 
the flexibility provided in these final regulations regarding the 
average income test.

Special Analyses

Regulatory Planning and Review--Economic Analysis

    Executive Orders 12866 and 13563 direct agencies to assess costs 
and benefits of available regulatory alternatives and, if regulation is 
necessary, to select regulatory approaches that maximize net benefits 
(including potential economic, environmental, public health and safety 
effects, distributive impacts, and equity). Executive Order 13563 
emphasizes the importance of quantifying both costs and benefits, of 
reducing costs, of harmonizing rules, and of promoting flexibility.
    These final regulations have been designated as subject to review 
under Executive Order 12866 pursuant to the Memorandum of Agreement 
(April 11, 2018) (MOA) between the Treasury Department and the Office 
of Management and Budget (OMB) regarding review of tax regulations. The 
Office of Information and Regulatory Affairs has designated these final 
regulations as significant under section 1(b) of the MOA.

A. Background

    The Tax Reform Act of 1986, Public Law 99-514, 100 Stat. 2085, 
created the low-income housing credit under section 42 of the Code. 
Section 42(a) provides that the credit amount earned by a qualified 
low-income building depends on the number of low-income units in the 
building, among other factors. Among other requirements, a low-income 
unit as defined in section 42(i)(3) must be rent-restricted, and the 
individuals occupying the unit must meet the income limitation 
applicable to the project of which the building is a part.
    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, 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 AMGI. 
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. To be rent restricted, a 
unit must have maximum gross rent no more than 30 percent of the unit's 
income limitation.
    The 2018 Act added section 42(g)(1)(C), which contains a third 
minimum set-aside test--the average income test. A project meets the 
minimum requirements of the average income test if 40 percent or more 
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 specific 
unit. (In the case of a project described in section 142(d)(6), 40 
percent in the preceding sentence is replaced by 25 percent.) For a 
project to meet the average income test, among other criteria, the 
average of the imputed income limitations must not exceed 60 percent of 
AMGI.

B. Baseline

    The Treasury Department and the IRS have assessed the benefits and 
costs of these final regulations relative to a no-action baseline 
reflecting anticipated Federal income tax-related behavior in the 
absence of these regulations.

C. Economic Analysis

    These final regulations provide guidance on the average income test

[[Page 61499]]

under section 42(g)(1)(C). Despite the absence of this guidance, 
between 2018 and 2022 approximately 200 taxpayers elected the average 
income test for projects containing, in the aggregate, just over 2,000 
buildings. With the benefit of this guidance, we project that an 
additional 100 taxpayers will elect the average income test annually, 
for around 1,000 buildings in aggregate, relative to a baseline 
scenario of no guidance.
    These final regulations are expected to increase election of the 
average income test because the regulations will reduce uncertainty 
regarding the interpretation of 42(g)(1)(C). Absent these regulations, 
some taxpayers might shy away from the average income test, fearing 
adverse tax consequences if their interpretation of the statute is 
determined to be incorrect as well as lost time and expense for 
litigation, even if their interpretation is eventually confirmed. 
Instead, these or other taxpayers would elect either the 20-50 test or 
the 40-60 test.
    Projects electing the average income test may be more financially 
stable and more likely to be mixed income than if they had to rely on 
the 20-50 or 40-60 tests; however, in aggregate, the final regulations 
are expected to have essentially no immediate effect on the number of 
affordable housing units produced. The pool of potential low-income 
housing credits allocated by state housing agencies is capped annually 
and is generally oversubscribed. Thus any increase in allocated credits 
flowing to projects electing the average income test is expected to be 
offset by a concomitant reduction in credits flowing to projects 
electing one of the other two set-aside tests.
    Despite having no measurable impact on the stock of affordable 
housing, these final regulations will likely have some economic effect. 
First, there will likely be a minor efficiency gain to taxpayers 
electing the average income set-aside compared to the situation of 
taxpayers that, in the absence of this guidance, would experience 
uncertainty interpreting section 42(g)(1)(C). These taxpayers may save 
on consulting fees or hours of effort. Second, there may be a minor 
efficiency gain from avoiding time spent in litigation regarding the 
interpretation of section 42(g)(1)(C). These are unambiguous benefits 
of providing the final regulations, even if quantitatively small. 
Third, there may be costs associated with the record-keeping 
requirements of these final regulations. In Section II of these Special 
Analyses, we estimate that the annual paperwork burden for this 
regulation is $676,712 in aggregate. These costs fall upon low-income 
housing tax credit (LIHTC) building owners who choose to incur them 
when electing the average income test.
    Less directly, the final regulations will likely result in a 
marginal geographic redistribution in the location of LIHTC-supported 
housing, away from densely populated areas and towards more sparsely 
populated ones. Absent an option to elect the average income test, 
property owners seeking LIHTCs must rely on either the 20-50 or 40-60 
tests. These tests set a single income standard for all LIHTC-
generating units in a building. For a building to be financially 
feasible, its owners must be confident that there is a sufficiently 
large pool of potential renters having incomes in these relatively 
narrow ranges (just under 50 or 60 percent of AMGI). These conditions 
are more easily met in densely populated areas.
    In contrast, with income averaging, developers have leeway to 
establish a variety of income limitations in a building. Thus, in a 
sparsely populated area where there are not enough people in the 
relatively narrow required range of incomes to support a 20-50 or 40-60 
building, an average income building may be financially feasible. 
Despite the low population density, the wider range of potential tenant 
incomes may enable the building owner to fill the low-income units with 
qualifying tenants from that vicinity. That ability could make the 
difference in whether or not the project is feasible.
    To be sure, most of the effect of the average income test on the 
geographic distribution of affordable housing is a direct consequence 
of statutory amendments to section 42 made by the 2018 Act, independent 
of this regulatory guidance. However, to the extent that the final 
regulations encourage some taxpayers to use the average income test who 
otherwise would not, the regulations reinforce the statutory effect. 
The end result is a marginal transfer of economic well-being from 
renters and LIHTC property developers in densely populated areas 
towards renters and LIHTC property developers in sparsely populated 
areas.

II. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520) (PRA) 
requires that a Federal agency obtain the approval of OMB before 
collecting information from the public, whether such collection of 
information is mandatory, voluntary, or required to obtain or retain a 
benefit. The collections of information contained in these regulations 
has been approved by OMB under control number 1545-0988.
    The collections of information that are needed for certainty and 
administrability of the final regulations are included in Sec.  1.42-
19T of the temporary regulations. Section 1.42-19T(c)(1) provides 
recordkeeping and reporting requirements related to the identification 
of a qualified group of units for each of (i) satisfaction of the 
average income set-aside test and (ii) applicable fraction 
determinations. Section 1.42-19T(c)(2) provides reporting requirements 
to the Agency with jurisdiction over a project. Section 1.42-
19T(c)(3)(iv) provides recordkeeping and reporting requirements related 
to designations of the imputed income limitations for residential 
units. Section 1.42-19T(d)(2) provides recordkeeping and reporting 
requirements related to changing a unit's designated imputed income 
limitation.
    This information in the collections of information will generally 
be used by the IRS and Agencies for tax compliance purposes and by 
taxpayers to facilitate proper reporting and compliance. Specifically, 
the collections of information in Sec.  1.42-19T apply to taxpayer 
owners of projects that receive the low-income housing credit and elect 
the average income set-aside. With respect to the recordkeeping 
requirements in Sec.  1.42-19T(c)(3)(iv) and (d)(2) and section 
42(g)(1)(C)(ii)(I) requires that the taxpayer designate the imputed 
income limitations of the units taken into account for purposes of the 
average income test. Thus, the recordkeeping requirements that are 
provided allow for a process of designation that will result in a 
reliable record of both the original designations of the imputed income 
limitations of low-income units and any redesignations of units' 
limitations within a project.
    The recordkeeping rules in Sec.  1.42-19T(c)(1) with respect to a 
qualified group of units are similarly needed to ensure there is a 
reliable record to show that the units used for purposes of the average 
income set-aside test, and for determining a building's applicable 
fraction were part of a group of units within the project whose average 
designated imputed income limitations do not exceed 60 percent of AMGI. 
This limitation is consistent with the requirement in section 
42(g)(1)(C)(ii)(II). The annual reporting requirements in Sec.  1.42-
19T(c)(1) and (3) and (d)(2) are also similar in substance to other 
annual certifications required of taxpayers. For example, minimum 
certifications by taxpayers are required in qualified

[[Page 61500]]

allocation plans as provided in Sec.  1.42-5(c). The reporting 
requirements in these final regulations also provide added flexibility 
by allowing the applicable Agency to determine the time and manner that 
the reporting is made under Sec.  1.42-19T(c)(2)(i). Also, Sec.  1.42-
19T(c)(4) gives Agencies the ability to waive any failure of reporting 
on a case-by-case basis.
    A summary of paperwork burden estimates follows:
    Estimated number of respondents: Approximately 200 taxpayers 
elected the average income test for just over 2,000 buildings between 
2018 and 2022. When viewed annually, we project that approximately 100 
additional taxpayers will have eligible buildings and 1,000 additional 
buildings will be eligible under the average income test.
    Estimated burden per response: We estimate that identifying which 
units are for use in the average income set-aside test and applicable 
fraction determinations and designating a unit's imputed income 
limitation takes an average of 15 minutes per unit. Based on an 
estimated average of 15 units per building and an average 15 minutes of 
time per unit, an impacted taxpayer will incur an average of 225 
minutes per building to record the additional designations due to the 
flexibility under the regulations for the average income test. Total 
average annual burden for recording the designations per building is 
11,250 hours (15 units x 15 minutes x 3,000 buildings).
    Taxpayers are also required to report redesignation of units, and 
why they are required to redesignate units during the year. For 
purposes of this analysis, we assume that an average of 4 units per 
building will be redesignated annually. We estimate each redesignation 
will take an average of 10 minutes. Thus, we estimate the average 
number of minutes per year to record redesignations for an impacted 
taxpayer to be 40 minutes per building for a total average annual 
burden of 2,000 hours (40 minutes x 3,000 buildings).
    In addition, we estimate an annual reporting burden related to the 
expanded flexibility rules to average 20 minutes per impacted taxpayer 
for a total burden of 100 hours (20 minutes x 300 taxpayers).
    Estimated frequency of response: Annual.
    Estimated total burden hours: The annual burden hours for this 
regulation is estimated to be 13,350 hours. Using a monetization rate 
of $50.69 per hour (2020 dollars), the burden for this regulation is 
$676,712 for impacted taxpayers.
    A Federal agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless the 
collection of information displays a valid control number.

III. Regulatory Flexibility Act

    Pursuant to the Regulatory Flexibility Act (RFA) (5 U.S.C. chapter 
6), it is hereby certified that this final 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 final 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 final 
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. In addition, affected 
taxpayers, including some who end up not electing the average income 
test) will incur minimal costs in reading and understanding the 
regulations. The Treasury Department and the IRS estimate that the 
burden involved in reading and understanding the regulations will be 
approximately 3 to 5 hours and largely will be borne by advisors and 
trade media. A portion of the cost to such advisors and trade media 
will be passed on to taxpayers.
    As described in more detail in the Paperwork Reduction Act section 
of this preamble, approximately 200 taxpayers elected the average 
income test between 2018 and 2022. When that figure is viewed annually, 
the Treasury Department and the IRS project that approximately 100 
additional taxpayers will elect the average income test due to the 
final regulations. For the 300 taxpayers affected, the annual burden 
hours for this regulation is estimated in the Paperwork Reduction Act 
analysis to be 13,350 hours. Thus, the average annual burden hours 
amount to 44.5 hours per affected small entity. This estimate reflects 
all recordkeeping and reporting requirements associated with the final 
regulations, including (i) identifying which units are for use in the 
average income set-aside test, (ii) identifying which units are for use 
in applicable fraction determinations, (iii) designating a unit's 
imputed income limitation, (iv) reporting redesignation of units, (v) 
reporting reasons why units are redesignated, and (v) the reporting 
burden related to the expanded flexibility rules.
    Monetized at $50.69 per hour (2020 dollars), the average annual 
burden hours represent a cost of $2,256 per affected small entity. This 
amount is likely quite small relative to the entity's revenue. A 
precise estimate of typical revenue is not possible with the data 
available to the Treasury Department and the IRS. However, the Treasury 
Department and the IRS estimate that the typical annual LIHTC 
allocation to an affected entity is between $125,000 and $1,450,000. 
Relative to these sums, the $2,256 annual cost of the regulations is 
not a significant economic impact.
    Accordingly, it is hereby certified that these regulations will not 
have a significant economic impact on a substantial number of small 
entities within the meaning of section 601(6) of the RFA.
    For the applicability of the RFA to the temporary regulations, 
refer to the Special Analyses section of the preamble to the notice of 
proposed rulemaking published in the Proposed Rules section in this 
issue of the Federal Register.

IV. Section 7805(f)

    Pursuant to section 7805(f), the proposed regulation was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small business, and no comments were 
received. The Treasury Department and the IRS also requested comments 
from the public.

V. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) 
requires that agencies assess anticipated costs and benefits and take 
certain other actions before issuing a final rule that includes any 
Federal mandate that may result in expenditures in any one year by a 
State, local, or tribal government, in the aggregate, or by the private 
sector, of $100 million in 1995 dollars, updated annually for 
inflation. This final rule does not include any Federal mandate that 
may result in expenditures by State, local, or tribal governments, or 
by the private sector in excess of that threshold.

VI. Executive Order 13132: Federalism

    Executive Order 13132 (Federalism) prohibits an agency from 
publishing any rule that has federalism implications if the rule either 
imposes substantial, direct compliance costs on State and local 
governments, and is not required by statute, or preempts State law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive order. These regulations do

[[Page 61501]]

not have federalism implications and do not impose substantial direct 
compliance costs on State and local governments or preempt State law 
within the meaning of the Executive order.

VII. Congressional Review Act

    Pursuant to the Congressional Review Act (5 U.S.C. 801 et seq.), 
the Office of Information and Regulatory Affairs designated this rule 
as not a ``major rule,'' as defined by 5 U.S.C 804(2).

Drafting Information

    The principal authors of these regulations are Dillon Taylor, 
Office of the Associate Chief Counsel (Passthroughs and Special 
Industries), and Michael J. Torruella Costa, formerly at 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.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

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

    Authority:  26 U.S.C. 7805 * * *
    Section 1.42-15 also issued under 26 U.S.C. 42(n);
* * * * *
    Section 1.42-19 also issued under 26 U.S.C. 42(n);
    Section 1.42-19T also issued under 26 U.S.C. 42(n);
* * * * *

0
Par. 2. Section 1.42-0 is amended by:
0
1. In the introductory text, removing ``1.42-18'' and adding ``1.42-
19'' in its place.
0
2. In Sec.  1.42-15:
0
i. Revising paragraph (c).
0
ii. Adding paragraphs (c)(1) and (2) and (c)(2)(i) through (iv).
0
iii. Revising paragraph (i).
0
iv. Adding paragraphs (i)(1) and (2).
0
3. Adding a heading and entries for Sec.  1.42-19.
    The additions and revisions read as follows:


Sec.  1.42-0  Table of contents.

* * * * *
Sec.  1.42-15 Available unit rule.
* * * * *
    (c) Exceptions.
    (1) In general.
    (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) Average income set-aside.
    (b) Definition of low-income unit and qualified group of units.
    (1) Definition of low-income unit.
    (2) Definition of qualified group of units.
    (3) Identification of qualified groups of units.
    (i) Average income set-aside test.
    (ii) Applicable fraction determinations.
    (iii) Identification of units.
    (c) Procedures.
    (1) [Reserved]
    (2) [Reserved]
    (3) Designation of imputed income limitations.
    (i) Timing of designation.
    (ii) 10-percent increments.
    (iii) Continuity.
    (iv) [Reserved]
    (4) [Reserved]
    (d) Changing a unit's designated imputed income limitation.
    (1) Permitted changes.
    (i) Federally permitted changes.
    (ii) Housing credit agency (Agency)-permitted changes.
    (iii) Certain laws.
    (iv) Tenant movement.
    (v) Restoring compliance with average income requirements.
    (2) [Reserved]
    (e) Examples.
    (f) Applicability dates.
    (1) General rule.
    (2) Designations of occupied units.
    (3) Applicability of this section to taxable years beginning before 
January 1, 2023.

0
Par. 3. Section 1.42-15 is amended by:
0
1. Revising the definition of Over-income unit in paragraph (a).
0
2. In paragraph (c):
0
i. Revising the heading.
0
ii. Designating the text as paragraph (c)(1) and adding a heading for 
newly designated paragraph (c)(1).
0
3. Adding paragraph (c)(2).
0
4. In paragraph (i):
0
i. Revising the heading.
0
ii. Designating the text as paragraph (i)(1).
0
5. In newly designated paragraph (i)(1):
0
i. Adding a heading.
0
ii. Removing ``This section'' and adding ``Except for paragraph (c)(2) 
of this section, this section'' in its place.
0
6. Adding paragraph (i)(2).
    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) or 
(B) (that is, the 20-50 or 40-60 tests), 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) (that is, the average income test), 
over-income unit means a residential unit described in Sec.  1.42-
19(b)(1)(i) through (iii) 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) In general. * * *
    (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 described in Sec.  1.42-19(b)(1)(ii) 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. Where multiple units in a building are over-income 
units at the same time--
    (A) The order in which available units are occupied makes no 
difference for

[[Page 61502]]

purposes of complying with the rules in this section (next available 
unit rule); and
    (B) In making imputed income limitation designations, the taxpayer 
must take into account the limitations described in paragraphs 
(c)(2)(iii) and (iv) of this section.
    (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 unit 
described in Sec.  1.42-19(b)(1)(ii) if--
    (A) Any residential unit described in Sec.  1.42-19(b)(1)(i) 
through (iii) 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. The limitation described in this paragraph 
(c)(2)(iv) is--
    (A) In the case of a unit that was described in Sec.  1.42-
19(b)(1)(i) through (iii) prior to becoming vacant, the imputed income 
limitation designated with respect to the 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 (consistent with section 
42(g)(1)(C)(ii)(III)) for that available unit under Sec.  1.42-19(c) 
such that the average of all imputed income designations of residential 
units in the project does not exceed 60 percent of area median gross 
income (AMGI).
    (v) Example. The operation of paragraph (c)(2) of this section 
(that is, the next available unit rule for the average income test) is 
illustrated by the following example.
    (A) Facts. (1) A single-building housing project received an 
allocation of housing credit dollar amount for 10 low-income units. The 
taxpayer who owns the project constructs the building with 10 
identically sized units and elects the average income test. In the 
first year, the taxpayer intended to have 8 units that will qualify as 
low-income units (within the meaning of Sec.  1.42-19(b)(1)), and 2 
units that are market-rate units. The taxpayer properly and timely 
designates the imputed income limitations for the 8 units as follows: 4 
units at 80 percent of AMGI; and 4 units at 40 percent of AMGI.

                  Table 1 to Paragraph (c)(2)(v)(A)(1)
------------------------------------------------------------------------
                                       Imputed income  limitation of the
              Unit No.                               unit
------------------------------------------------------------------------
1...................................  80 percent of AMGI.
2...................................  80 percent of AMGI.
3...................................  80 percent of AMGI.
4...................................  80 percent of AMGI.
5...................................  Market Rate.
6...................................  40 percent of AMGI.
7...................................  40 percent of AMGI.
8...................................  40 percent of AMGI.
9...................................  40 percent of AMGI.
10..................................  Market Rate.
------------------------------------------------------------------------

    (2) In the first taxable year of the credit period (Year 1), the 
project is fully leased and occupied by income-qualified residents in 
Units ##1-4 and 6-9. In Year 2, Unit #1 and Unit #6 become over-income. 
The tenant residing in Unit #5 vacated that unit. Taxpayer then 
designated an imputed income limitation of 40 percent of AMGI for Unit 
#5. Later in Year 2, the tenant residing in Unit #10 vacated that unit. 
Taxpayer designated an imputed income limitation of 80 percent of AMGI 
for Unit #10. After those designations, Unit #10 was occupied by a new 
income-qualified tenant, and then later, Unit #5 was occupied by a new 
income-qualified resident.
    (B) Analysis. Taxpayer sought to maintain the status of the over-
income units (Unit #1 and Unit #6) as units described in Sec.  1.42-
19(b)(1)(ii). As the then-market rate units (Units ##5 and 10) became 
available to rent, Taxpayer designated imputed income limitations for 
them at 40 percent and 80 percent of AMGI, respectively. Immediately 
after each designation, the average of the designations in the project 
does not exceed 60 percent AMGI. Pursuant to the rule in paragraph 
(c)(2)(ii) of this section, when there are multiple over-income units, 
Taxpayer is not required to rent the next-available units in a specific 
order, even though they may have different imputed income limitations. 
Thus, Taxpayer complied with the rules of the next available unit rule, 
and Unit #1 and Unit #6 maintain status as units described in Sec.  
1.42-19(b)(1)(ii).
* * * * *
    (i) Applicability dates--(1) In general. * * *
    (2) Applicability dates under the average income test. The 
requirements of 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 taxable years beginning after December 31, 2022. A 
taxpayer may choose to apply this section to a taxable year beginning 
after October 12, 2022, and before January 1, 2023, provided that the 
taxpayer chooses to apply Sec.  1.42-19 to the same taxable year.

0
Par. 4. Section 1.42-19 is added to read as follows:


Sec.  1.42-19   Average income test.

    (a) Average income set-aside. A project for residential rental 
property satisfies the average income test in section 42(g)(1)(C) for a 
taxable year if the project contains a qualified group of units (within 
the meaning of paragraph (b)(2) of this section) that constitutes 40 
percent or more of the residential units in the project. (In the case 
of a project described in section 142(d)(6), ``40 percent'' in the 
preceding sentence is replaced with ``25 percent.'')
    (b) Definition of low-income unit and qualified group of units--(1) 
Definition of low-income unit. For purposes of this section, a 
residential unit is a low-income unit if and only if -
    (i) Such unit is rent-restricted (as defined in section 42(g)(2));
    (ii) The individuals occupying such unit satisfy the imputed income 
limitation of that unit designated by the taxpayer in accordance with 
paragraphs (c)(3) and (d) of this section and with Sec.  1.42-19T(c) 
and (d), or the unit meets the requirements under section 42(g)(2)(D);
    (iii) No provision in section 42 (including section 42(i)(3)(B)-
(E)) or in the regulations under section 42 denies low-income status to 
that unit; and
    (iv) The unit is part of a qualified group of units under paragraph 
(b)(2) of this section.
    (2) Definition of qualified group of units. A group of residential 
units is a qualified group of units for a taxable year if and only if--
    (i) Each unit in the group satisfies the requirements of paragraphs 
(b)(1)(i) through (iii) of this section; and
    (ii) The average of the imputed income limitations of all of the 
units in the group does not exceed 60 percent of area median gross 
income (AMGI).
    (3) Identification of qualified groups of units--(i) Average income 
set-aside test. For each taxable year in the extended use period, the 
taxpayer must identify a qualified group of units that constitute 40 
percent or more of the residential units in the project. The 
requirements in paragraph (b)(3)(iii) of this section apply to these 
identifications.
    (ii) Applicable fraction determinations. For each taxable year in 
the extended use period, the taxpayer must identify a qualified group 
of units to be used in determining the applicable fractions for the 
buildings in the project.

[[Page 61503]]

    (A) Identification of the units in the qualified group of units 
used for determining applicable fractions. The residential units that 
are identified for purposes of this paragraph (b)(3)(ii) include the 
units that, under paragraph (b)(3)(i) of this section, are included in 
the qualified group of units identified for purposes of the set-aside 
qualification of the project. The taxpayer may identify additional 
units for inclusion in the group of units used in determining the 
applicable fractions for buildings in the project provided that the 
resulting group is a qualified group of units within the meaning of 
paragraph (b)(2) of this section.
    (B) Computing applicable fractions of buildings. For a taxable 
year, the applicable fraction of a building in a project is computed 
using the units that are in the particular building and that are also 
in the qualified group of units for the project identified for purposes 
of this paragraph (b)(3)(ii). The units included in the applicable 
fraction of a building do not have to be a qualified group of units on 
their own. See Example 4 of paragraph (e) of this section.
    (iii) Identification of units. The recordkeeping and reporting 
requirements in Sec.  1.42-19T(c)(1) apply both to the identification 
of units that is required by paragraph (b)(3)(i) of this section and 
the identification of units that is described in paragraph (b)(3)(ii) 
of this section.
    (c) Procedures. (1)-(2) [Reserved]
    (3) Designation of imputed income limitations--(i) Timing of 
designation. (A) Before a unit is first occupied as a low-income unit, 
or, except as provided in paragraph (c)(3)(i)(B) of this section, is 
first occupied under a changed income limit, the taxpayer must 
designate the unit's imputed income limitation or changed imputed 
income limitation.
    (B) For an occupied unit that is subject to a change in imputed 
income limitation pursuant to paragraph (d) of this section, the 
taxpayer must designate the unit's changed imputed income limitation 
not later than the end of the taxable year in which the change occurs.
    (ii) 10-percent increments. Under section 42(g)(1)(C)(ii)(III), a 
designation is valid only if it is one of the following: 20 percent, 30 
percent, 40 percent, 50 percent, 60 percent, 70 percent, or 80 percent 
of AMGI.
    (iii) Continuity. Except as provided in paragraph (d) of this 
section, the imputed income limitation of a residential unit does not 
change.
    (iv) [Reserved]
    (4) [Reserved]
    (d) Changing a unit's designated imputed income limitation--(1) 
Permitted changes. Notwithstanding paragraph (c)(3)(iii) of this 
section, the taxpayer may change the imputed income limitation of a 
unit in the following circumstances subject to the timing of 
designation requirement in paragraph (c)(3)(i)(B) of this section.
    (i) Federally permitted changes. Permission for the change is 
contained in IRS forms, instructions, or guidance published in the 
Internal Revenue Bulletin pursuant to Sec.  601.601(d)(2)(ii)(b) of 
this chapter.
    (ii) Housing credit agency (Agency)-permitted changes. The Agency 
with jurisdiction of the project has issued public written guidance 
that provides conditions for a permitted change and that applies to all 
average income test projects under the jurisdiction of the Agency.
    (iii) Certain laws. The change in designation is required or 
appropriate to enhance protections contained in the following, as 
amended--
    (A) The Americans with Disabilities Act of 1990 (ADA), Pub. L. 101-
336, 104 Stat. 328, 42 U.S.C. 12101, et seq.;
    (B) The Fair Housing Amendments Act of 1988, Pub. L. 100-430, 102 
Stat.1619, 42 U.S.C. 3601, et. seq.;
    (C) The Violence Against Women Act of 1994, Pub. L. 103-322, 108 
Stat. 1902, 34 U.S.C. 12291, et. seq.;
    (D) The Rehabilitation Act of 1973, Pub. L. 93-112, 87 Stat. 394, 
29 U.S.C. 701, et seq.; or
    (E) Any other State, Federal, or local law or program that protects 
tenants and that is identified pursuant to paragraph (d)(1)(i) or (ii) 
of this section.
    (iv) Tenant movement. If a current income-qualified tenant moves to 
a different unit in the project--
    (A) The unit to which the tenant moves has its imputed income 
designation, if any, changed to the limitation of the unit from which 
the tenant is moving; and
    (B) The vacated unit takes on the prior limitation, if any, of the 
tenant's new unit.
    (v) Restoring compliance with average income requirements. If one 
or more units lose low-income status or if there is a change in the 
imputed income limitation of some unit and if either event would cause 
a previously qualifying group of units to cease to be described in 
paragraph (b)(2)(ii) of this section, then the taxpayer may designate 
an imputed income limitation for a market rate unit or may reduce the 
existing imputed income limitations of one or more other units in the 
project in order to restore compliance with the average income 
requirement. The rule in this paragraph (d)(1)(v) may be applied to 
market-rate, vacant, or low-income units, but, in the case of occupied 
units, the current tenants must qualify under the new, lower imputed 
income limitation.
    (2) [Reserved]
    (e) 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 
10-unit building to have 100 percent low-income occupancy. The taxpayer 
properly and timely designates the imputed income limitations for the 
10 units as follows: 5 units at 80 percent of AMGI; and 5 units at 40 
percent of AMGI. Also, for the first credit year, the taxpayer follows 
proper procedure in identifying 4 units as the qualified group of units 
that are to be used for qualifying under the average income set-aside 
(Units ##1, 2, 6, and 7). Additionally, for the first credit year, the 
taxpayer follows proper procedure in identifying all 10 units as the 
qualified group of units that are to be used for the applicable 
fraction determination. All of the units in the project are described 
in paragraphs (b)(1)(i) through (iii) of this section.

                    Table 1 to Paragraph (e)(1)(i)(A)
------------------------------------------------------------------------
                                       Imputed income limitation of the
              Unit No.                               unit
------------------------------------------------------------------------
1...................................  80 percent of AMGI.
2...................................  80 percent of AMGI.
3...................................  80 percent of AMGI.
4...................................  80 percent of AMGI.
5...................................  80 percent of AMGI.
6...................................  40 percent of AMGI.
7...................................  40 percent of AMGI.
8...................................  40 percent of AMGI.
9...................................  40 percent of AMGI.
10..................................  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. The identified groups are qualified groups under 
paragraph (b)(2) of this section. All units in both of the groups are 
described in paragraphs (b)(1)(i) through (iii) of this section, and 
the averages of the imputed income limitations of both the 4-unit group 
(Units ##1, 2, 6, and 7) and the 10-unit group do not exceed 60 percent 
of AMGI.
    (A) Average income set-aside. The project qualifies under the 
average income set-aside because the identified group of 4 units (Units 
##1, 2, 6, and 7) is a qualified group of units that

[[Page 61504]]

comprise at least 40% of the residential units in the project.
    (B) Qualified basis. All 10 units in the identified qualified group 
of units are used in the applicable fraction determination when 
calculating qualified basis for purposes of determining the annual 
credit amount under section 42(a).
    (2) Example 2--(i) Facts. Assume the same facts as Example 1 of 
paragraph (e)(1) of this section. In Year 2, Unit #6 (which has a 
designated imputed income limitation of 40 percent of AMGI) becomes 
uninhabitable. Repair work on Unit #6 is completed in Year 3. For Year 
2, Taxpayer identifies the following as a qualified group of units that 
are to be used for both the set-aside requirement and the applicable 
fraction determination: Units ##1-4 and 7-10. For Year 3, Taxpayer 
identifies all 10 units as the qualified group of units that are to be 
used for the set-aside requirement and the applicable fraction 
determination.
    (ii) Analysis. For Year 2, the identified group is a qualified 
group under paragraph (b)(2) of this section. All 8 units in the group 
are described in paragraphs (b)(1)(i) through (iii) of this section, 
and the average of the imputed income limitations of the 8 units in the 
group of units does not exceed 60 percent of AMGI.
    (A) Average income set-aside. For Year 2, the project qualifies for 
the average income set-aside because the project contains a qualified 
group of units that comprises at least 40% of the residential units in 
the project.
    (B) Qualified basis. To determine qualified basis in Year 2, the 8 
units in the identified qualified group of units are used in the 
applicable fraction determination when calculating qualified basis for 
purposes of determining the annual credit amount under section 42(a). 
Unit #6 could not have been identified in the qualified group of units 
for use in the applicable fraction determination because its lack of 
habitability prevents it from being a low-income unit. Further, 
Taxpayer could not have identified all 9 of the habitable units to be 
used in the qualified group of units for the applicable fraction 
determination because the average of imputed income limitations of 
those 9 exceeds 60 percent of AMGI. Taxpayer had a choice of which of 
Units ##1-5 it was going to not identify for use in the applicable 
fraction determination. Omitting any one of them reduces the average 
limitation of the remaining group of 8 units to an amount that does not 
exceed 60 percent of AMGI. Given taxpayer's decision to leave out Unit 
#5, Units ##1, 2, 3, 4, 7, 8, 9, and 10 are taken into account in the 
applicable fraction.
    (C) Recapture. At the close of Year 2, Unit #6's unsuitability for 
occupancy precludes it from being described in paragraph (b)(1)(iii) of 
this section. Unit #6's resulting failure to be a low-income unit 
prevents it from being in a qualified group for purposes of computing 
the applicable fraction. The decline in the applicable fraction yields 
a decline in qualified basis, which results in credit recapture under 
section 42(j) for Year 2. Additionally, Unit #5 is not a low-income 
unit because the taxpayer did not include it in the qualified group of 
units identified for determining the building's applicable fraction. 
The exclusion of Unit #5 from the qualified group of units further 
reduces the applicable fraction for Year 2 and so reduces qualified 
basis for that year as well. Thus, this exclusion increases the credit 
recapture amount under section 42(j).
    (D) Restoration of habitability and of qualified basis. As 
described in the facts in paragraph (e)(2)(i) of this section, in Year 
3, after repair work is complete, the formerly uninhabitable Unit #6 is 
again occupied by a qualified tenant at the same imputed income 
limitation, and the Taxpayer identifies all 10 units as the qualified 
group of units that are to be used for the set-aside requirement and 
the applicable fraction determination. The identified group is a 
qualified group under paragraph (b)(2) of this section. All 10 units in 
the group are described in paragraphs (b)(1)(i) through (iii) of this 
section, and the average of the imputed income limitations of the 10 
units in the group of units does not exceed 60 percent of AMGI. For 
Year 3, all 10 units are included in the qualified group of units for 
purposes of the average income set-aside test and are a qualified group 
of units for the applicable fraction determination.
    (3) Example 3--(i) Facts. Assume the same facts as Example 2 of 
paragraph (e)(2) of this section, except that the income for the tenant 
residing in Unit #5 has declined so that tenant's income does not 
exceed 60 percent of AMGI. For Year 2, taxpayer timely redesignates 
Unit #5 pursuant to the rule in paragraph (d)(1)(v) of this section so 
that the imputed income limitation is 60 percent of AMGI instead of 80 
percent of AMGI. Taxpayer also makes revisions so that Unit #5 is rent-
restricted under the redesignated imputed income limitation. Taxpayer 
identifies 9 units (Units ##1-5 and 7-10) as the qualified group of 
units that are to be used for the set-aside requirement and the 
applicable fraction determination.

                     Table 2 to Paragraph (e)(3)(i)
------------------------------------------------------------------------
                                       Imputed income limitation of the
              Unit No.                               unit
------------------------------------------------------------------------
1...................................  80 percent of AMGI.
2...................................  80 percent of AMGI.
3...................................  80 percent of AMGI.
4...................................  80 percent of AMGI.
5...................................  60 percent of AMGI.
6...................................  40 percent of AMGI.
7...................................  40 percent of AMGI.
8...................................  40 percent of AMGI.
9...................................  40 percent of AMGI.
10..................................  40 percent of AMGI.
------------------------------------------------------------------------

    (ii) Analysis. For Year 2, the identified group is a qualified 
group under paragraph (b)(2) of this section. All 9 units in the group 
are described in paragraphs (b)(1)(i) through (iii) of this section, 
and the average of the imputed income limitations of the 9 units in the 
group of units does not exceed 60 percent of AMGI.
    (A) Average income set-aside. For Year 2, project contains a 
qualified group of units that comprises at least 40% of the residential 
units in the project.
    (B) Qualified basis. To determine qualified basis, all 9 units in 
the identified qualified group of units are used in the applicable 
fraction determination when calculating qualified basis for purposes of 
determining the annual credit amount under section 42(a). Unit #6 could 
not have been identified in the qualified group of units for use in the 
applicable fraction determination because its lack of habitability 
prevents it from being a low-income unit. Thus, Units ##1, 2, 3, 4, 5, 
7, 8, 9, and 10 are taken into account in the applicable fraction 
determination.
    (C) 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 #6's unsuitability for occupancy prohibits it from 
being a low-income unit. Unit #6's failure to be a low-income unit 
results in a credit recapture amount under section 42(j) for Year 2 
related to Unit #6. Because Units ##1-5 and 7-10 are all included in 
the qualified group of units for use in the applicable fraction 
determination, Units ##1-5 and 7-10 are included in qualified basis for 
Year 2 when determining the recapture amount.
    (4) Example 4--(i) Facts. (A) A multiple-building housing project 
consisting of two buildings received an allocation of housing credit 
dollar amount, and the taxpayer who owns the project elects the average 
income test. The taxpayer intends for the buildings (each containing 5 
units) to have 100

[[Page 61505]]

percent low-income occupancy. The taxpayer properly and timely 
designates the imputed income limitations for the 10 units in Buildings 
1 and 2 as follows: Building A contains 2 units at 80 percent of AMGI 
and 3 units at 40 percent of AMGI; and Building B contains 2 units at 
40 percent of AMGI and 3 units at 80 percent of AMGI.

                    Table 3 to Paragraph (e)(4)(i)(A)
------------------------------------------------------------------------
                                       Imputed income limitation of the
        Building A, Unit No.                         unit
------------------------------------------------------------------------
    A1..............................  80 percent of AMGI.
    A2..............................  80 percent of AMGI.
    A3..............................  40 percent of AMGI.
    A4..............................  40 percent of AMGI.
    A5..............................  40 percent of AMGI.
------------------------------------------------------------------------
Building B, Unit No.
------------------------------------------------------------------------
    B1..............................  40 percent of AMGI.
    B2..............................  40 percent of AMGI.
    B3..............................  80 percent of AMGI.
    B4..............................  80 percent of AMGI.
    B5..............................  80 percent of AMGI.
------------------------------------------------------------------------

    (B) In the first taxable year of the credit period (Year 1), the 
project is fully leased and occupied. Also, for the first credit year, 
the taxpayer follows proper procedure in identifying all 10 units as a 
qualified group of units for the minimum set-aside and the applicable 
fraction determination.
    (ii) Analysis. For Year 1, the identified group is a qualified 
group under paragraph (b)(2) of this section. All 10 units in the group 
are described in paragraphs (b)(1)(i) through (iii) of this section, 
and the average of the imputed income limitations of the 10 units in 
the group of units does not exceed 60 percent of AMGI.
    (A) Average income test. The multiple-building project meets the 
average income test as the project contains a qualified group of units 
that comprises at least 40% of the residential units in the project. 
The fact that the average of the income limitations of the units in 
Building B exceeds 60 percent of AMGI does not impact this result.
    (B) Qualified basis. To determine qualified basis, all 10 units in 
the identified qualified group of units across Building A and Building 
B are used in the applicable fraction determination when calculating 
qualified basis of each building for purposes of determining the annual 
credit amount under section 42(a). The fact that the average of the 
units in Building B exceeds 60 percent of AMGI does not impact the 
applicable fraction of Building B because the average of the identified 
group of units across both buildings does not exceed 60 percent of 
AMGI.
    (5) Example 5--(i) Facts. A single-building housing project 
received an allocation of housing credit dollar amount, and the 
taxpayer who owns the project elects the average income test. During 
Year 2 of the credit period, the tenant residing in a unit with a 
designated imputed income limitation of 40 percent of AMGI moves to a 
market-rate unit within the same project. The tenant's income continues 
to be at or below 40 percent of AMGI.
    (ii) Analysis. Under the rule in paragraph (d)(1)(iv) of this 
section, when the current income-qualified tenant moves to a different 
unit in the project, the unit to which the tenant moves is eligible for 
the taxpayer to designate as a unit with a designated imputed income 
limitation of 40 percent of AMGI. If the taxpayer makes those 
designations, the unit vacated by the tenant takes on the prior 
limitation, if any, of the tenant's new unit. In this situation, the 
vacated unit formerly occupied by the tenant is now a market-rate unit.
    (6) Example 6--(i) Facts. A single-building housing project 
received an allocation of housing credit dollar amount, and the 
taxpayer who owns the project elects the average income test. During 
Year 2 of the credit period, the disability status under the ADA of a 
tenant changes, and therefore under the provisions of the ADA, the 
tenant now needs to reside in a different unit with different 
accommodations. The tenant currently resides in a unit with a 
designated imputed income limitation of 40 percent of AMGI. A unit that 
would meet the tenant's needs is available on the first-floor of the 
building, but it was previously a low-income unit with a designated 
imputed income limitation of 70 percent of AMGI and thus a higher 
maximum gross rent than the tenant's current unit. The tenant moves to 
the first-floor unit.
    (ii) Analysis. The tenant's move was required under the ADA. 
Accordingly, the taxpayer is permitted to change the designation of the 
imputed income limitation of the first-floor unit so that the unit's 
designation is 40 percent of AMGI. Under paragraph (d)(1)(iv) of this 
section, the vacated unit takes on the prior limitation of 70 percent 
of AMGI of the tenant's new unit.
    (f) Applicability dates-(1) In general. Except as provided in 
paragraph (f)(3) of this section, this section applies to taxable years 
beginning after December 31, 2022.
    (2) Designations of occupied units. (i) If a residential unit is 
occupied at the end of the most recent taxable year ending before the 
first taxable year to which this section applies and if the unit is to 
be taken into account as a low-income unit under this section as of the 
beginning of the first taxable year to which this section applies, then 
not later than the first day of such first taxable year, the taxpayer 
must designate an imputed income limitation for the unit. The first 
taxable year to which this section applies means the first taxable year 
beginning after December 31, 2022, if paragraph (f)(1) of this section 
applies, or the taxable year described in paragraph (f)(3) of this 
section if the taxpayer chooses to apply paragraph (f)(3) of this 
section.
    (ii) The designation required by paragraph (f)(2)(i) of this 
section must comply with paragraph (c)(3)(ii) of this section and Sec.  
1.42-19T(c)(3)(iv), without taking into account Sec.  1.42-19T(c)(4). 
Section 1.42-19T(c)(2) applies to these designations, except that the 
Agency may allow the notification to be made along with any other 
notifications for the first taxable year beginning after December 31, 
2022.
    (iii) The designated imputed income limitation for the unit may not 
be less than the income that the current occupant of the unit had when 
that occupancy began.
    (3) Applicability of this section to taxable years beginning before 
January 1, 2023. A taxpayer may choose to apply this section to a 
taxable year beginning after October 12, 2022, and before January 1, 
2023, provided that the taxpayer chooses to apply Sec.  1.42-15 to the 
same taxable year.

0
Par. 5. Section 1.42-19T is added to read as follows:


Sec.  1.42-19T  Average income test (temporary).

    (a)-(b) [Reserved]
    (c) Procedures--(1) Identification of low-income units for use in 
the average income set-aside test or the applicable fraction 
determination--(i) In general. For a taxable year, a taxpayer must 
follow the procedures described in paragraph (c)(1)(ii) of this section 
to identify--
    (A) A qualified group of units that satisfy the average income set-
aside test; and
    (B) A qualified group of units used to determine the applicable 
fraction.
    (ii) Recording and communicating. The procedures described in this 
paragraph (c)(1)(ii) are--
    (A) Recording the identification in its books and records, where 
the identification must be retained for a period not shorter than the 
record retention requirement under Sec.  1.42-5(b)(2); and
    (B) Communicating the annual identifications to the applicable 
housing

[[Page 61506]]

credit agency (Agency) as provided in paragraph (c)(2) of this section.
    (2) Notifications to the Agency with jurisdiction over a project--
(i) Agency flexibility. An Agency may establish the time and manner in 
which information is annually provided to it.
    (ii) Example. An Agency may allow a taxpayer to describe a current 
year's information by reporting differences from the previous year's 
information or by reporting that there are no such differences. Various 
Agencies may choose to apply this manner of reporting to the identity 
of a qualified group of units for use in the average income set-aside 
or applicable fraction determination, or the imputed income limits 
designated for the various units in a project.
    (3) Designation of imputed income limitations. (i)-(iii) [Reserved]
    (iv) Recording, retention, and annual communications related to 
designations. A taxpayer designates a unit's imputed income limitation 
by recording the limitation in its books and records, where it must be 
retained for a period not shorter than the record retention requirement 
under Sec.  1.42-5(b)(2). The preceding sentence applies both to units 
whose first occupancy is as a low-income unit and to previously market-
rate units that are converted to low-income status. The designation 
must also be communicated annually to the applicable Agency as provided 
in paragraph (c)(2) of this section.
    (4) Waiver for failure to comply with procedural requirements. On a 
case-by-case basis, the Agency has the discretion to waive in writing 
any failure to comply with the requirements of paragraph (c)(1) or (2) 
or (c)(3)(iv) of this section up to 180 days after discovery of the 
failure, whether by taxpayer or Agency. If an Agency exercises this 
discretion, then the relevant requirements are treated as having been 
satisfied. In such a case, the tax consequences under this section 
correspond to that deemed satisfaction.
    (d) Changing a unit's designated imputed income limitation. (1) 
[Reserved]
    (2) Process for changing a unit's designated imputed income 
limitation. The taxpayer effects a change in a unit's imputed income 
limitation by recording the limitation in its books and records, where 
it must be retained for a period not shorter than the record retention 
requirement under Sec.  1.42-5(b)(2). The new designation must also be 
communicated to the applicable Agency as provided in paragraph (c)(2) 
of this section and must become part of the annual report to the Agency 
of income designations. The prior designation must be retained in the 
books and records for the period specified in paragraph (c)(3)(iv) of 
this section. A designation under this paragraph (d)(2) is considered 
to be made in a manner consistent with paragraph (c)(3) of this 
section.
    (e) [Reserved]
    (f) Applicability dates--(1) In general. Except as provided in 
paragraph (f)(3) of this section, this section applies to taxable years 
beginning after December 31, 2022.
    (2) Designations of occupied units. (i) If a residential unit is 
occupied at the end of the most recent taxable year ending before the 
first taxable year to which this section applies and if the unit is to 
be taken into account as a low-income unit under this section as of the 
beginning of the first taxable year to which this section applies, then 
not later than the first day of such first taxable year, the taxpayer 
must designate an imputed income limitation for the unit. The first 
taxable year to which this section applies means the first taxable year 
beginning after December 31, 2022, if paragraph (f)(1) of this section 
applies, or the taxable year described in paragraph (f)(3) of this 
section if the taxpayer chooses to apply paragraph (f)(3) of this 
section.
    (ii) The designation required by paragraph (f)(2)(i) of this 
section must comply with Sec.  1.42-19(c)(3)(ii) and paragraph 
(c)(3)(iv) of this section, without taking into account paragraph 
(c)(4) of this section. Paragraph (c)(2) of this section applies to 
these designations, except that the Agency may allow the notification 
to be made along with any other notifications for the first taxable 
year beginning after December 31, 2022.
    (iii) The designated imputed income limitation for the unit may not 
be less than the income that the current occupant of the unit had when 
that occupancy began.
    (3) Applicability of this section to taxable years beginning before 
January 1, 2023. A taxpayer may choose to apply this section to a 
taxable year beginning after October 12, 2022, and before January 1, 
2023, provided that the taxpayer chooses to apply Sec.  1.42-15 to the 
same taxable year.
    (4) Expiration date. The applicability of this section expires on 
October 7, 2025.

Paul J. Mamo,
Assistant Deputy Commissioner for Services and Enforcement.

    Approved: September 30, 2022.
Lily L. Batchelder,
Assistant Secretary (Tax Policy).
[FR Doc. 2022-22070 Filed 10-7-22; 11:15 am]
BILLING CODE 4830-01-P