The U.S. Department of Housing and Urban Development (HUD) issued guidelines for its mark-to-market demonstration program to address the problem of excessive subsidy costs in Federal Housing Administration-insured Section 8 rental housing projects.

Section 8 rents, based on HUD determined fair market rents (FMRs), are supposed to be roughly equivalent to rents actually charged on comparable unsubsidized projects. When Section 8 projects were developed, however, higher costs were built into the rents to assure project feasibility. With annual rent adjustments, the gap between subsidized rents and market rents has widened over the years.

The Section 8 contracts are now coming up for renewal and, since subsidies are tied to rents, above-market rents mean higher subsidy costs.

The mark-to-market demonstration is aimed at ways to reduce Section 8 costs on FHA-insured projects, where HUD also has ultimate responsibility for the mortgage. The basic concept is to write down the mortgage to the amount which can be supported by market-level rents, with the FHA insurance fund absorbing the cost of the writedown.

Initially, HUD had planned to terminate all project-based Section 8 contracts, giving tenant-based certificates or vouchers to eligible tenants. But, the department has modified its position, leaving open the possibility that some project-based contracts may be renewed.

Under the demonstration program, HUD can restructure mortgages covering up to 15,000 units. The guidelines give priority to projects with Section 8 extending beyond 1997 and proposals that will reduce rents to market levels, maximize the reduction of federal expenditures, eliminate or reduce the existing FHA mortgage insurance and serve the housing needs of low- and very low-income tenants.

Restructuring can be handled by HUD staff or through third-party contractors, and HUD will give priority to proposals that don't involve HUD personnel.

Mechanisms for modifying project debt service to accommodate subsidy reductions include forgiveness and cancellation of part of the mortgage debt and making part of the monthly payments from the FHA insurance fund for the remainder of the mortgage term.

Owner participation in the demonstration is voluntary, and a potential disincentive is the prospect that debt forgiveness could result in taxable income. The guidelines emphasize that owners will be responsible for mitigating any adverse tax consequences.

* Priority is given to projects with Section 8 extending beyond 1997.

* Priority is also given to proposals that will reduce rent to market levels, maximize the reduction of federal expenditures, eliminate or reduce the existing FHA mortgage insurance and serve the housing need of low- and very low-income tenants.

* Owners will be responsible for mitigating any adverse tax consequences.