In-lieu fees in inclusionary zoning are cash payments a residential developer makes to a local government instead of building the below-market-rate units the zoning ordinance would otherwise require on-site. The money goes into a dedicated housing trust fund that pays for affordable housing elsewhere in the jurisdiction. Most inclusionary programs set aside roughly 10 to 20 percent of new units for lower-income households, and the fee gives developers a second path to compliance when building those units inside a particular project doesn’t pencil out. How the fee is calculated, what legal limits constrain it, and how the money actually gets spent vary widely across jurisdictions, and the details matter more than most developers expect.
The Choice at Permitting
An inclusionary zoning ordinance typically presents developers with a choice during permitting: include a set number of affordable units in the project, or pay a per-unit fee. The decision usually happens early in the planning stage because it shapes the entire project budget. Developers weigh site constraints, construction costs, financing terms, and the complexity of managing units at different price points under one roof. For small projects, luxury high-rises, or sites where affordable tenants would face limited transit and services, paying the fee often makes more financial sense.
Paying also eliminates the long-term compliance burden that comes with on-site affordable units. Those units bring decades of rent restrictions, income verification for tenants, and regular reporting to the local housing authority. The in-lieu payment is a one-time obligation that closes the developer’s file with the planning department once the check clears. Most jurisdictions treat the fee as a standard administrative option, not a special accommodation, so choosing it doesn’t require extra approvals or variances. Some ordinances pair the fee with a density bonus that lets developers build more total units than the base zoning would allow.
When the Requirement Applies
Inclusionary ordinances don’t apply to every project. Most programs kick in only when a development reaches a minimum size, commonly somewhere between 5 and 10 units. Below that threshold, the project is usually exempt. Above it, the developer owes either affordable units or the fee.
The required set-aside percentage typically falls between 10 and 20 percent of total units. “Affordable” in this context almost always means affordable to households earning below a specified percentage of the Area Median Income. HUD defines low-income households as those earning 80 percent or less of AMI, very low-income at 50 percent or less, and extremely low-income at 30 percent or less. Local programs usually target one or more of these tiers. A developer building 100 units in a city with a 15 percent set-aside at 80 percent AMI would need to provide 15 affordable units or pay the in-lieu fee on those 15.
Rental and for-sale projects often have separate rules, and the fee amounts differ between the two. Some programs exempt projects already receiving public affordability subsidies. Checking the local ordinance early is the only way to know the exact trigger, percentage, and AMI target for a given project.
How the Fee Amount Is Set
The most common calculation starts with the affordability gap: the difference between what a market-rate unit sells or rents for and what a household at the target income can afford. If a market-rate condo sells for $500,000 and the affordable price for a qualifying household is $200,000, the per-unit fee approximates that $300,000 difference. The theory is that the fee should cover what it would cost to produce an equivalent affordable unit somewhere else in the jurisdiction.
Other jurisdictions take a simpler approach. Some charge a flat fee per square foot of market-rate construction, commonly $15 to $45 per square foot. Others set a fixed dollar amount per unbuilt affordable unit, often $150,000 to $350,000 depending on local construction costs. Fixed schedules give developers more predictability during underwriting, which is why many cities prefer them despite the trade-off of being less tightly tied to actual housing production costs.
Fractional Units
When the set-aside percentage produces a fractional unit requirement, most ordinances round down to the nearest whole unit and charge a proportional fee for the remainder. A 12-unit project with a 15 percent requirement generates an obligation of 1.8 affordable units. The developer builds one on-site unit and pays 80 percent of the per-unit in-lieu fee for the 0.8 balance. This keeps small projects from being forced into an all-or-nothing choice.
Annual Adjustments
Fee schedules don’t stay static. Most jurisdictions adjust rates annually against benchmarks like the Consumer Price Index, the Bureau of Labor Statistics Employment Cost Index, or construction-specific measures like the Engineering News-Record Construction Cost Index. HUD publishes its own Operating Cost Adjustment Factors each year.1Federal Register. Notice of Certain Operating Cost Adjustment Factors for 2026 Local councils also periodically commission updated nexus studies to confirm that fee levels still reflect actual production costs. When fees lag the market, the trust fund collects less than it costs to build the units the fees are meant to replace.
Constitutional Limits on Fee Amounts
A local government can’t just pick a number. In-lieu fees are a form of development exaction, and the Supreme Court has imposed constitutional guardrails on how far governments can go when conditioning permits on payments.
The Essential Nexus Test
In Nollan v. California Coastal Commission (1987), the Court held that any condition attached to a building permit must have an “essential nexus” to a legitimate public interest. If the condition doesn’t actually further the stated purpose, it functions as an unconstitutional taking of property.2Justia Law. Nollan v. California Coastal Commission, 483 U.S. 825 (1987) For in-lieu fees, this means the government must show that new market-rate housing actually increases demand for affordable housing, creating the nexus between the development and the fee.
The Rough Proportionality Test
Seven years later, Dolan v. City of Tigard (1994) added a second requirement. Even when the nexus exists, the fee must be “roughly proportional” to the development’s actual impact. The city has to make an individualized determination connecting the fee amount to what the project will cost the community in new affordable housing demand. No precise mathematical formula is required, but a vague assertion that more housing creates more need isn’t enough.3Justia Law. Dolan v. City of Tigard, 512 U.S. 374 (1994) The burden of proof falls on the government.
Monetary Exactions After Koontz
The case that matters most for in-lieu fees came in 2013. In Koontz v. St. Johns River Water Management District, the Court confirmed that the Nollan/Dolan tests apply to government demands for money, not just demands for land. The Court held that “the government’s demand for property from a land-use permit applicant must satisfy the requirements of Nollan and Dolan even when the government denies the permit and even when its demand is for money.”4Justia Law. Koontz v. St. Johns River Water Management District, 570 U.S. 595 (2013) Before Koontz, some jurisdictions argued that cash payments escaped that scrutiny. That argument is dead.
The Nexus Study
In practice, these tests mean that any jurisdiction imposing an in-lieu fee needs a formal nexus study. The study quantifies how new market-rate development increases demand for affordable housing and calculates how much it would cost to offset that impact. A weak or outdated study is the single biggest vulnerability in any inclusionary program. Developers who believe a fee is disproportionate to their project’s actual impact have constitutional grounds to challenge it, and courts will strike down fees that lack adequate factual support.
Where the Money Goes
Once a developer pays the fee, the funds go into a dedicated housing trust fund that keeps the money ring-fenced for affordable housing rather than being absorbed into the general budget. Typical eligible uses include acquiring land for affordable developments, financing construction by nonprofit housing providers, rehabilitating aging buildings to preserve existing affordable units, and providing down payment assistance or rental subsidies to qualifying households.
Pooling fees from multiple developments gives cities an advantage: the trust fund can finance larger, 100-percent-affordable projects that produce far more units than any single developer would have built on-site. A mid-rise market-rate project might owe three affordable units under the set-aside, but the fee equivalent from a dozen such projects can fund a 50-unit building operated by a nonprofit with deep compliance expertise.
The trade-off is accountability. Fees paid into a trust fund cannot always be traced directly to specific affordable units the way on-site requirements can. Some cities have been slow to spend accumulated funds, and when the money sits idle during a construction boom, it buys fewer units later. For programs receiving federal Housing Trust Fund dollars the rules are stricter: funds must be committed within 24 months and fully spent within five years, or HUD recaptures them.5eCFR. 24 CFR Part 93 – Housing Trust Fund Local trust funds don’t always carry equivalent deadlines.
Affordability Duration
Units built with trust fund money typically carry deed restrictions that keep them affordable for decades. The federal Housing Trust Fund requires a minimum 30-year affordability period for both rental and homeownership units.6eCFR. 24 CFR 93.302 – Qualification as Affordable Housing: Rental Housing Local restriction periods range from as few as 10 years to permanent, with medians of roughly 30 to 45 years for rental housing. About one in five programs nationally mandate permanent affordability. A short restriction means the unit eventually converts to market rate, and the community loses the benefit the fee was meant to create.
Tax Treatment for Developers
Developers sometimes assume in-lieu fees are deductible as ordinary business expenses in the year they’re paid. They’re not. The IRS treats impact fees and similar government-mandated construction-related payments as indirect costs that must be capitalized into the cost basis of the property being developed.7IRS. Revenue Ruling 2002-9
The legal basis is the uniform capitalization rules under Section 263A of the Internal Revenue Code, which requires developers to capitalize both direct costs (materials, labor) and indirect costs incurred by reason of the production activity. Impact fees and in-lieu fees fall into the indirect category.8Office of the Law Revision Counsel. 26 U.S. Code 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses The practical effect is that the fee becomes part of the building’s depreciable basis and is recovered over the applicable depreciation period, 27.5 years for residential rental property, or on sale for a for-sale project, rather than reducing taxable income immediately. A $300,000 fee a developer expected to write off in year one instead spreads across nearly three decades of depreciation deductions, which matters for cash flow planning even though the long-run tax impact is similar.9Office of the Law Revision Counsel. 26 U.S. Code 162 – Trade or Business Expenses
Enforcement and Non-Compliance
The most common enforcement tool is the simplest one: the local government withholds the certificate of occupancy until the developer either builds the required affordable units or pays the in-lieu fee. No CO means no tenants, no sales, and no revenue. For most developers carrying construction loans, that’s more than enough motivation to comply on time.
When compliance involves off-site affordable construction rather than a cash payment, enforcement gets harder. If a developer receives permission to build affordable units on a separate site but then fails to complete them after the market-rate project is already occupied, the city’s leverage drops. Some jurisdictions address this by requiring performance bonds or financial guarantees upfront, with penalty surcharges if the off-site units aren’t completed on schedule. Others require that affordable units be occupied before the market-rate project can open. Beyond CO withholding, consequences can include municipal liens on the property, daily fines, and in extreme cases revocation of building permits.
On-Site Units vs. the Fee
From a city’s perspective, on-site affordable units are more certain and more immediate. They get built as part of the development, they’re occupied on the same timeline as the market-rate units, and they create income-diverse communities within a single building. Some jurisdictions strongly prefer on-site production and only allow the fee as an exception for projects where on-site inclusion is genuinely impractical.
From a developer’s perspective, the fee is almost always simpler. It eliminates the design constraints of mixing unit types, avoids the ongoing compliance burden, and converts an uncertain long-term obligation into a known upfront cost. Lenders understand a line item in the development budget better than they understand 30 years of rent restrictions on a portion of the building.
The tension plays out at the program level too. When too many developers choose the fee, the inclusionary aspect of the policy weakens: market-rate buildings remain economically homogeneous, and the affordable units end up concentrated in separate locations that may offer fewer amenities or less convenient access to jobs and transit.10HUD. Evaluation of In-Lieu Fees and Offsite Construction as Incentives for Affordable Housing Production Pooled fee revenue, on the other hand, can fund projects operated by housing specialists who maintain affordability more effectively than a market-rate developer managing a handful of below-market units on the side. The programs that produce the most affordable housing tend to set fees high enough to make on-site construction genuinely competitive while still deploying the collected revenue efficiently.