Entity Setup
Entity Setup for Low-Income Housing Projects: Leveraging New IRS Compliance Regs
New final regulations around low-income housing compliance and the average income test introduce both opportunities and compliance obligations for entities setting up affordable housing projects.
By NomadicTax Research Team • 5-8 min read • November 15, 2025
## Key Regulatory Updates for Low-Income Housing Credits (LIHC)
• The IRS issued **final regulations** modifying how the **average income test** is calculated under section 42 for low-income housing credit projects. These changes affect owners and state/local housing agencies monitoring compliance. ([irs.gov](https://www.irs.gov/irb/2025-43_IRB?utm_source=openai))
• Definitions such as “designated property” and “improvement” have also been clarified under final regulations, which will determine eligibility and required improvements. ([irs.gov](https://www.irs.gov/irb/2025-43_IRB?utm_source=openai))
## Setting Up a Compliant Entity: Structuring Tips
1. **Entity Type Matters.** For housing projects, entities often use partnerships or LLCs owning rental projects. The entity will need to ensure that it will satisfy the average income requirement under Section 42 and that its project qualifies for credit.
2. **State Agencies & Compliance.** State housing credit agencies must verify the average income test for tenants each year and enforce penalties when rent or income becomes non-compliant.
3. **Capital Stack Planning.** Equity investors rely on projected credit flows. Accurate income tests and improvement status (what qualifies) affect credit forecasts.
4. **Receive a Final Allocation.** Some projects may rely on “safe harbor” compliance. The change in regs for “designated property” and “substantial improvements” can shift whether a facility still qualifies under safe harbors or if full compliance rules apply.
## Practical Example
Imagine a 100-unit affordable housing project in Ohio, owned by a limited partnership. Under old regs, the state treated certain related party financial interest as designated property—using “associated property” rules. Under the new final regulations, those rules for associated property are removed. This might reduce compliance burden or shift determination of who owns what interest. But property improvement definitions being stricter could require additional project upgrades or limit credits if previous improvement assumptions were aggressive.
If your projections assumed substantial improvements on certain units, you’ll need to ensure your definitions meet the new regulatory standard. Missed compliance could lead to recapture.
## Actionable Insights for Developers & Investors
- Perform a **compliance audit** of your definitions of “designated property,” “associate property,” and “substantial improvement.” Align with the final regulations issued in IRB 2025-43. ([irs.gov](https://www.irs.gov/irb/2025-43_IRB?utm_source=openai))
- Update pro forma financials to factor in **new eligibility changes** for credits. Realistically model expected earned credit flows under the updated rules.
- Documentation is now more critical—particularly items like physical unit improvements, common area upgrades, and costs broken down by item. These support designations under Section 42 compliance.
- Seek partnerships or counsel with State Housing Agencies early to ensure project paperwork passes muster.
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**Why this matters:** affordable housing projects depend on accurate tax credit projections and compliance. The recent IRS final regulations reshape what qualifies, who owns eligible interest, and how income is averaged. For those setting up entities now (or acquiring existing projects), early alignment with the new rules could save money and avoid recapture risk.