[Federal Register Volume 62, Number 187 (Friday, September 26, 1997)]
[Rules and Regulations]
[Pages 50503-50506]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-25493]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8732]
RIN 1545-AT60


Available Unit Rule

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations concerning the 
treatment of low-income housing units in a building that is occupied by 
individuals whose incomes increase above 140 percent of the income 
limitation applicable under section 42(g)(1). These regulations affect 
owners of those buildings who claim the low-income housing tax credit.

DATES: These regulations are effective September 26, 1997.
    For dates of applicability of these regulations, see Sec. 1.42-
15(i).

FOR FURTHER INFORMATION CONTACT: David Selig, (202) 622-3040 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On May 30, 1996, the IRS published a notice of proposed rulemaking 
in the Federal Register (PS-29-95 at 61 FR 27036) proposing amendments 
to the Income Tax Regulations (26 CFR part 1) under section 42(g)(2)(D) 
of the Internal Revenue Code. A public hearing was scheduled for 
September 17, 1996, pursuant to a notice of public hearing published 
simultaneously with the notice of proposed rulemaking. However, the IRS 
received no requests to speak at the public hearing, and no public 
hearing was held. Written comments responding to the notice were 
received. After consideration of all the comments, the proposed 
regulations are adopted as revised by this Treasury decision.

Explanation of Revisions and Summary of Comments

    The general rule in section 42(g)(2)(D)(i) provides that if the 
income

[[Page 50504]]

of an occupant of a low-income unit increases above the income 
limitation applicable under section 42(g)(1), the unit continues to be 
treated as a low-income unit. This general rule only applies if the 
occupant's income 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 section 42(g)(2)(D)(i). 
Under this exception, the unit ceases being treated as a low-income 
unit when two 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), or above 170 percent for a deep rent 
skewed project described in section 142(d)(4)(B) (applicable income 
limitation). When this occurs, the unit becomes an over-income unit. 
The second condition is that a new occupant, whose income exceeds the 
applicable income limitation (nonqualified resident), occupies any 
residential unit in the building of a comparable or smaller size 
(comparable unit).

Rules and Definitions

    One commentator suggested that the available unit rule under the 
proposed regulations did not clearly indicate whether the aggregate 
income of all occupants of a unit is taken into account. Accordingly, 
the final regulations clarify that an over-income unit means 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), or above 170 percent of the applicable income 
limitation for deep rent skewed projects described in section 
142(d)(4)(B).
    Commentators requested that the final regulations specify whether a 
comparable unit is measured by floor space or number of bedrooms. The 
final regulations provide that a comparable unit must be measured by 
the same method the taxpayer used to determine qualified basis for the 
credit year in which the comparable unit became available.
    Some commentators stated that the provision in the proposed 
regulations that all available comparable units (not just the ``next 
available'' unit) must be rented to qualified residents to continue 
treating an over-income unit as a low-income unit is inconsistent with 
the title of section 42(g)(2)(D)(ii). Although the title of that 
provision uses the term next available unit, the text of the rule 
provides that if any available comparable unit is occupied by a 
nonqualified resident, the over-income unit ceases to be treated as a 
low-income unit. This means that if a building has more than one over-
income unit, renting any available comparable unit (a comparably sized 
or smaller unit) to a qualified resident preserves the status of all 
over-income units as low-income units. Similarly, if any available 
comparable unit is rented to a nonqualified resident, all over-income 
units for which the available unit was a comparable unit lose their 
status as low-income units; thus, comparably sized or larger over-
income units would lose their status as low-income units. In operation, 
this means that the owner must continue to rent any available 
comparable unit to a qualified resident until the percentage of low-
income units in a building (excluding the over-income units) is equal 
to the percentage of low-income units on which the credit is based. At 
that point, failure to maintain the over-income units as low-income 
units has no immediate significance. (However, the failure to maintain 
an over-income unit as a low-income unit may affect the owner's 
decision of whether or not to rent a particular available unit at 
market rate at a later time.) Consequently, the final regulations 
provide that all available comparable units in the building, not only 
the next available comparable unit, must be rented to qualified 
residents to retain the low-income status of the over-income units.

Application of Rules on a Building by Building Basis

    The proposed regulations provide that in a project containing more 
than one low-income building, the available unit rule applies 
separately to each building. Some commentators suggested that the 
regulations should permit residents of over-income units to move to 
available units in different buildings within the same low-income 
housing project without violating the available unit rule. However, 
because the requirements under section 42 must be satisfied on a 
building by building basis, the final regulations provide that the 
available unit rule only permits a current resident to move to another 
unit within the same building of a low-income housing project.
    In addition, in response to requests from several commentators, the 
final regulations make clear that when a current resident moves to a 
different unit within the same low-income building, the units exchange 
status. (See example 2 of Sec. 1.42-15(g) of the proposed regulations 
and Sec. 1.42-15(h) of the final regulations.) Thus, the newly occupied 
unit adopts the status of the vacated unit, and the vacated unit 
assumes the status the newly occupied unit had immediately prior to its 
occupancy by the qualifying residents.

Timing Issues

    The methods of committing rental units to tenants varies in 
different jurisdictions. However, it is a common rental practice to 
have some form of preliminary reservation for a unit prior to the date 
on which a lease is signed or the unit is occupied. Thus, several 
commentators have requested clarification that once a unit is reserved 
for a prospective tenant, it is no longer treated as available for 
purposes of the available unit rule. Accordingly, the final regulations 
provide that a unit is not available for purposes of the available unit 
rule when the unit is no longer available for rent due to a reservation 
that is binding under local law.
    Finally, financing arrangements using obligations 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). The requirements 
under section 142(d) may differ from those under section 42. 
Accordingly, the final regulations provide that the rules under the 
final regulations are not intended as an interpretation of the 
applicable rules under section 142.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
does not apply to these regulations, and, because these regulations do 
not impose on small entities a collection of information requirement, 
the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. 
Therefore, a Regulatory Flexibility Analysis is not required. Pursuant 
to section 7805(f) of the Internal Revenue Code, the notice of proposed 
rulemaking preceding these regulations was submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.
    Drafting Information: The principal author of these regulations is 
David Selig, Office of the Assistant Chief Counsel (Passthroughs and 
Special Industries), IRS. However, other personnel from the IRS and 
Treasury Department participated in their development.

[[Page 50505]]

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

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

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

    Par. 2. Section 1.42-15 is added to read as follows:


Sec. 1.42-15  Available unit rule.

    (a) Definitions. The following definitions apply to this section:
    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 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), or above 170 
percent of the applicable income limitation for deep rent skewed 
projects described in section 142(d)(4)(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) Exception. 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).
    (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,

[[Page 50506]]

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) Effective date. This section applies to leases entered into or 
renewed on and after September 26, 1997.
Michael P. Dolan,
Acting Commissioner of Internal Revenue.

    Approved: August 26, 1997.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 97-25493 Filed 9-25-97; 8:45 am]
BILLING CODE 4830-01-U