By Chris Saunders, Audit Director, Sherbert CPA, PC csaunders@sherbertcpa.com
Effective September 30, 2025, the IRS published final regulations outlining record-keeping and reporting requirements for the average income test for purposes of the low-income housing credit. These final regulations are designed to enhance compliance and the administration of projects electing the average income test as a minimum set-aside option.
The final regulations primarily impact:
- Building owners of low-income housing projects that use the average income test to qualify for credits, and
- State or local housing credit agencies that allocate credits and monitor compliance of low-income housing credits.
Brief Background
The low-income housing credit, enacted by the Tax Reform Act of 1986, incentivizes the development and operation of affordable rental housing through tax credits based on a building’s qualified basis. To qualify, a project must satisfy one of three minimum set-aside tests, including the average income test added by the Consolidated Appropriations Act, 2018.
Under the Average Income Test:
- At least 40% of a building’s residential units must be both rent-restricted and occupied by qualifying households.
- The average tenant income across these units must not exceed 60% of area median gross income (AMGI).
- Each unit’s imputed income limitation must be set at one of seven levels: 20%, 30%, 40%, 50%, 60%, 70%, or 80% of AMGI.
- Taxpayers must identify and record a qualified group of units that satisfy the average income set-aside test, and a qualified group of units to be used to determine the applicable fraction.
Key Changes Under the New Guidance
- The new guidance eliminates the “cliff test” allowing for corrections and flexible qualified group identifications, preventing total project disqualification due to isolated issues.
- The new guidance allows agencies to have more flexibility and discretion in how information is submitted, reducing administrative burdens.
Recommendations
To avoid loss of qualified basis or IRS recapture of credits, we advise our clients using the average income test to follow these recommendations:
- Maintain detailed records of qualified unit groups, imputed income limits (20%–80% AMGI), and designations for set-aside and applicable fraction to help track average income test compliance.
- Coordinate with agencies on their preferred reporting formats and timely submit their required reports.
- Continuously monitor to ensure units remain rent-restricted and occupied by qualifying tenants.
- Changes to income limits are prospective only. The IRS does not allow retroactive change to income designations for any unit after a taxable year has closed.
- Train staff on monitoring requirements to help avoid non-compliance, but if non-compliance occurs, ensure the issue is addressed within the 180-day correction window.
Here is a link to the final regulations: Federal Register :: Section 42, Low-Income Housing Credit Average Income Test Procedures
As your trusted advisors, The Sherbert Group will keep you informed of important updates in the real estate tax credit industry and provide recommendations to help navigate your project through the complexities of applicable rules and regulations.