How the Gross Rent Floor Election Protects Rent from Falling Income Limits
To calculate the rent for your low-income units, you use HUD income limits. These are the same limits you use to determine whether households are qualified. The limits you use depend on the geographic location of your building and the percentage of area median gross income (AMGI) the owner and your state housing agency agreed to apply.
Tax credit rent is based on 30 percent of income limits and not 30 percent of a household’s actual income. So to calculate the annual rent, you would multiply the appropriate income limit by 30 percent. Then divide the annual rent by 12 to get the monthly rent. This monthly rent is called the “gross rent” and is the most you can charge a household for rent and utilities.
Under Internal Revenue Code (IRC) §42(g)(2)(A), a unit qualifies as a low-income unit when the gross rent doesn’t exceed 30 percent of the imputed income limit unit under IRC §42(g)(2)(C). IRC §42(g)(2)(A) includes a rent “floor” so that the income limits used to compute the rent are never less than the income limits used to compute the rents “for the earliest period the building was included in the determination of whether the project is a qualified low-income housing project.” In other words, gross rents at a tax credit site never have to fall below what they were the first credit year. This is known as the gross rent floor. And the IRS allows owners of LIHTC sites to select a gross rent floor for every building in a development based upon when credits were first allocated to the building or the date the building was first placed in service.
First-Year Income Limits
The IRS automatically provides two rent floors, one at carryover or the allocation date and one at the placed-in-service date under IRC Section 42. Under Revenue Procedure 94-57:
- If the taxpayer received an allocation of credit under IRC §42(h)(1), the IRS will treat the gross rent floor as taking effect on the date the state agency initially allocated the housing credit to the building.
- For a bond-financed building described in IRC §42(h)(4), the IRS will treat the gross rent floor as taking effect on the date the state agency initially issues a determination letter to the building.
Setting the rent floor at carryover or the allocation date fixes the rents at the level that was used for assessing the financial feasibility and underwriting of the site by the state agency and the owner near the time the owner applied for and received tax credits. Therefore, the lowest rents owners will be required to charge (the gross rent floor) are based on the income limits in effect when the building is allocated credits, unless the owner elects and notifies the housing credit agency of the election to treat the rent floor as taking effect on the date the building is placed in service.
Income limits start to apply to a site when it places in service. If the limits have gone down between allocation and the time the property places in service, the owner/agent won’t have to charge rents based on the lower income limits but will use the gross rent floor until rents based on the future income limits exceed the floor rents.
Example: An owner elects the 40/60 minimum set-aside on Form 8609. HUD issues reduced income limits effective Jan. 1, 2019. The revised maximum 60 percent gross rent is $400, which is below the calculated maximum rent floor of $500 in effect at the time the owner received the credit allocation. The owner has been charging $450 rent and a $50 utility allowance. There is no noncompliance. The owner may rely on his gross rent floor and continue to charge $500 in total rent.
Now let’s say the owner elected the 40/60 minimum set-aside on Form 8609 and elected to treat the rent floor as taking effect on the date the building was placed in service on July 12, 2018. And HUD then issued reduced income limits effective Jan. 1, 2019. The revised maximum 60 percent gross rent is $400, which is above the calculated rent floor of $300 at the time the owner placed the building in service. The owner may charge rent of $350 and a $50 utility allowance, for a total of $400.
Because income limits hold harmless, there’s no benefit to choosing the floor based on the placed-in-service date. But selecting to use the allocation date to determine the gross rent floor may benefit the owner in case of income/rent limit decreases after the allocation, but before the project is placed in service.
Gross Rents vs. Net Rents
For tax credit compliance purposes, “gross rent” means all payments by the tenant, including non-optional charges and payments for utilities other than telephone and cable. It’s important to realize that the gross rent floor election applies to gross rents only and that the floor doesn’t apply to net rents.
If the tenant pays utilities directly, the maximum rent is reduced by a utility allowance determined in accordance with rules under Section 8 of the U.S. Housing Act of 1937. Utility allowances must be updated at least annually. Federal, state, and local rental assistance payments such as Section 8 payments made on behalf of the tenant are not included in gross rent.
Therefore, even though the gross rent floor will never fall below what was in effect at the time credits were allocated or the placed-in-service date, the net rents can still fall below the rents that were initially charged, due to the utility allowance in place at the time.
Other Sources of Funding
It’s important to have an understanding of the funding sources of a site and any corresponding rules tied to those funding sources. With this understanding, you can make sure that the site remains in full compliance.
For example, funds from HUD’s HOME program and LIHTCs are often used together to finance affordable rental housing sites. To establish affordable rents in many markets, a site’s rents may not be enough to pay off a conventional mortgage. As a result, the equity raised from tax credits may not be sufficient to provide all of the additional capital required by the site. Often, HOME funds can be used to finance the remaining gap.
A site that combines these two sources of funds must comply with the requirements of both programs. In implementing the gross rent floor election, the owner must take into consideration any additional funding streams and the regulatory agreements tied to the additional funding. For a site with tax credits and HOME funding, the owner will have to understand and apply the most restrictive requirements regarding the two types of funding.
The gross rent floor election doesn’t apply to HOME funds. But the HOME program does have its own provision, stating that rents don’t have to fall below the HOME rents in effect at the time the HOME funds were committed. The gross rent floor election may still come into play at properties with tax credit and HOME funds though, as the rents allowed under the tax credit program, using the gross rent floor election, may be higher than the current tax credit rents but lower than the HOME rents.