(a) Definitions. The following definitions apply to this section:

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Applicable income limitation means the limitation applicable under section 42(g)(1) or, for deep rent skewed projects described in section 142(d)(4)(B), 40 percent of area median gross income.

Available unit rule means the rule in section 42(g)(2)(D)(ii).

Comparable unit means a residential unit in a low-income building that is comparably sized or smaller than an over-income unit or, for deep rent skewed projects described in section 142(d)(4)(B), any low-income unit. For purposes of determining whether a residential unit is comparably sized, a comparable unit must be measured by the same method used to determine qualified basis for the credit year in which the comparable unit became available.

Current resident means a person who is living in the low-income building.

Low-income unit is defined by section 42(i)(3)(A).

Nonqualified resident means a new occupant or occupants whose aggregate income exceeds the applicable income limitation.

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 § 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 § 1.42-19(b).

Qualified resident means an occupant either whose aggregate income (combined with the income of all other occupants of the unit) does not exceed the applicable income limitation and who is otherwise a low-income resident under section 42, or who is a current resident.

(b) General section 42(g)(2)(D)(i) rule. Except as provided in paragraph (c) of this section, notwithstanding an increase in the income of the occupants of a low-income unit above the applicable income limitation, if the income of the occupants initially met the applicable income limitation, and the unit continues to be rent-restricted—

(1) The unit continues to be treated as a low-income unit; and

(2) The unit continues to be included in the numerator and the denominator of the ratio used to determine whether a project satisfies the applicable minimum set-aside requirement of section 42(g)(1).

(c) Exceptions—(1) In general. A unit ceases to be treated as a low-income unit if it becomes an over-income unit and a nonqualified resident occupies any comparable unit that is available or that subsequently becomes available in the same low-income building. In other words, the owner of a low-income building must rent to qualified residents all comparable units that are available or that subsequently become available in the same building to continue treating the over-income unit as a low-income unit. Once the percentage of low-income units in a building (excluding the over-income units) equals the percentage of low-income units on which the credit is based, failure to maintain the over-income units as low-income units has no immediate significance. The failure to maintain the over-income units as low-income units, however, may affect the decision of whether or not to rent a particular available unit at market rate at a later time. A unit is not available for purposes of the available unit rule when the unit is no longer available for rent due to contractual arrangements that are binding under local law (for example, a unit is not available if it is subject to a preliminary reservation that is binding on the owner under local law prior to the date a lease is signed or the unit is occupied).

(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 § 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 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 § 1.42-19(b)(1)(ii) if—

(A) Any residential unit described in § 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 § 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 § 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 § 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 § 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.

(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 § 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 § 1.42-19(b)(1)(ii).

(d) Effect of current resident moving within building. When a current resident moves to a different unit within the building, the newly occupied unit adopts the status of the vacated unit. Thus, if a current resident, whose income exceeds the applicable income limitation, moves from an over-income unit to a vacant unit in the same building, the newly occupied unit is treated as an over-income unit. The vacated unit assumes the status the newly occupied unit had immediately before it was occupied by the current resident.

(e) Available unit rule applies separately to each building in a project. In a project containing more than one low-income building, the available unit rule applies separately to each building.

(f) Result of noncompliance with available unit rule. If any comparable unit that is available or that subsequently becomes available is rented to a nonqualified resident, all over-income units for which the available unit was a comparable unit within the same building lose their status as low-income units; thus, comparably sized or larger over-income units would lose their status as low-income units.

(g) Relationship to tax-exempt bond provisions. Financing arrangements that purport to be exempt-facility bonds under section 142 must meet the requirements of sections 103 and 141 through 150 for interest on the obligations to be excluded from gross income under section 103(a). This section is not intended as an interpretation under section 142.

(h) Examples. The following examples illustrate this section:

Example 1.This example illustrates noncompliance with the available unit rule in a low-income building containing three over-income units. On January 1, 1998, a qualified low-income housing project, consisting of one building containing ten identically sized residential units, received a housing credit dollar amount allocation from a state housing credit agency for five low-income units. By the close of 1998, the first year of the credit period, the project satisfied the minimum set-aside requirement of section 42(g)(1)(B). Units 1, 2, 3, 4, and 5 were occupied by individuals whose incomes did not exceed the income limitation applicable under section 42(g)(1) and were otherwise low-income residents under section 42. Units 6, 7, 8, and 9 were occupied by market-rate tenants. Unit 10 was vacant. To avoid recapture of credit, the project owner must maintain five of the units as low-income units. On November 1, 1999, the certificates of annual income state that annual incomes of the individuals in Units 1, 2, and 3 increased above 140 percent of the income limitation applicable under section 42(g)(1), causing those units to become over-income units. On November 30, 1999, Units 8 and 9 became vacant. On December 1, 1999, the project owner rented Units 8 and 9 to qualified residents who were not current residents at rates meeting the rent restriction requirements of section 42(g)(2). On December 31, 1999, the project owner rented Unit 10 to a market-rate tenant. Because Unit 10, an available comparable unit, was leased to a market-rate tenant, Units 1, 2, and 3 ceased to be treated as low-income units. On that date, Units 4, 5, 8, and 9 were the only remaining low-income units. Because the project owner did not maintain five of the residential units as low-income units, the qualified basis in the building is reduced, and credit must be recaptured. If the project owner had rented Unit 10 to a qualified resident who was not a current resident, eight of the units would be low-income units. At that time, Units 1, 2, and 3, the over-income units, could be rented to market-rate tenants because the building would still contain five low-income units.Example 2.This example illustrates the provisions of paragraph (d) of this section. A low-income project consists of one six-floor building. The residential units in the building are identically sized. The building contains two over-income units on the sixth floor and two vacant units on the first floor. The project owner, desiring to maintain the over-income units as low-income units, wants to rent the available units to qualified residents. J, a resident of one of the over-income units, wishes to occupy a unit on the first floor. J’s income has recently increased above the applicable income limitation. The project owner permits J to move into one of the units on the first floor. Despite J’s income exceeding the applicable income limitation, J is a qualified resident under the available unit rule because J is a current resident of the building. The unit newly occupied by J becomes an over-income unit under the available unit rule. The unit vacated by J assumes the status the newly occupied unit had immediately before J occupied the unit. The over-income units in the building continue to be treated as low-income units.

(i) Applicability dates—(1) In general. Except for paragraph (c)(2) of this section, this section applies to leases entered into or renewed on and after September 26, 1997.

(2) Applicability dates under the average income test. The 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 § 1.42-19 to the same taxable year.

[T.D. 8732, 62 FR 50505, Sept. 26, 1997, as amended by T.D. 9967, 87 FR 61501, Oct. 12, 2022]